ACCT Mid Term-I Study Guide
ACCT Mid Term-I Study Guide ACCT 2101
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This 12 page Study Guide was uploaded by Varsha Mandiga on Sunday May 29, 2016. The Study Guide belongs to ACCT 2101 at Georgia State University taught by Kris J. Clark in Summer 2016. Since its upload, it has received 11 views.
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Date Created: 05/29/16
Principles of Accounting 1 Summer 2016 Study Guide for Midterm 1 Chapter 1: 1) Identify the advantages and disadvantages of the corporate form of business organization. Advantages: o Easier to transfer ownership: It is not especially difficult for a shareholder to sell shares in a corporation, though this is more difficult when the entity is privatelyheld. o Easier to raise funds: A publiclyheld corporation in particular can raise substantial amounts by selling shares or issuing bonds. o No Personal liability: The shareholders of a corporation are only liable up to the amount of their investments. The corporate entity shields them from any further liability. Disadvantages: o Double Taxation: Depending on the type of corporation, it may pay taxes on its income, after which shareholders pay taxes on any dividends received, so income can be taxed twice. o Excessive Tax Filings: Depending on the type of corporation, the various types of income and other taxes that must be paid can add up to a substantial amount of paperwork. o Independent Management: If there are many investors having no clear majority interest, the management team of a corporation can operate the business without any real oversight from the owners. 2) Identify internal and external users of financial information. Internal Users: Internal users of accounting information are managers who plan, organize, and run a business. These include marketing managers, production supervisors, general management, real estate, finance directors, human resources, and company officers. External Users: There are several types of external users of accounting information. Investors (owners) use accounting information to make decisions to buy, hold, or sell stock. Creditors such as suppliers and bankers use accounting information to evaluate the risks of selling on credit or lending money. 3) Define and identify assets, liabilities, and stockholders’ equity accounts and the accounting equation. Resources owned by a business are called assets. Claims of creditors are called liabilities. The owners' claim to assets is called stockholders' equity. 4) Identify Assets = Liabilities + Stockholders’ Equity. activities as operating, investing, or financing. All businesses are involved in three types of activities, financing, investing, and operating. The accounting information system keeps track of the results of each of these business activities. Financing: o Borrowing money (debt financing) Amounts owed are called liabilities. Party to whom amounts are owed are creditors. Notes payable and bonds payable are different types of liabilities. o Issuing (selling) shares of stock for cash. Payments to stockholders are called dividends. Common stock is the term used to describe the total amount paid in by stockholders for the shares they purchase. Investing: o Purchase of resources a company needs to operate: Computers, delivery trucks, furniture, buildings, etc. (property, plant, and equipment). Resources owned by a business are called assets. Cash is one of the more important assets. Investments are another example of an investing activity. Operating: o Once a business has the assets it needs, it can begin its operations. Revenues: The amounts earned from the sale of products (sales revenue, service revenue, and interest revenue). Inventory: Goods available for sale to customers. Accounts receivable: Right to receive money from a customer as the result of a sale. Expenses: Cost of assets consumed or services used. (cost of goods sold, selling, marketing, administrative, interest, and income taxes expense). Liabilities: Arising from expenses include accounts payable, interest payable, wages payable, sales taxes payable, and income taxes payable. Net Income: When revenues exceed expenses. Net Loss: When expenses exceed revenues. 5) Calculate components of the income statement, retained earnings statement, and balance sheet and identify the interrelationships. 6) Identify the purpose of the auditor’s report. Auditor’s opinion as to the fairness of the presentation of the financial position and results of operations and their conformance with generally accepted accounting principles. Chapter 2: 1) Identify the different categories of assets found on the balance sheet. Current assets: Cash ShortTerm Investments (debt investments) Accounts receivable and Notes receivable Inventories Supplies Prepaid expenses and other current assets LongTerm Investments: Stock investments Investments in real estate Property, plant, and equipment: Land Buildings Equipment and machinery Accumulates depreciation (Depreciation allocating the cost of assets to a number of years.) Intangible assets: Patents Goodwill Film Library Customer lists Sports franchises Cable television franchises Brands, and trademarks 2) Define a current asset. o Current assets are assets that a company expects to convert to cash or use up within one year or its operating cycle, whichever is longer. 3) Calculate earnings per share. o Earnings per share (EPS) measures the net income earned on each share of common stock. 4) Identify the reasons companies pay dividends. The thought process that management goes through in deciding whether to pay a dividend: Management must evaluate what its cash needs are. If it has uses for cash that will increase the value of the company (for example, building a new warehouse), then it should retain cash in the company. However, if it has more cash than it has valuable opportunities, it should distribute its excess cash as a dividend. 5) Working Capital. 6) Calculate the current ratio and understand its purpose. Liquidity ratios measure the shortterm ability to pay maturing obligations and to meet unexpected needs for cash. For every dollar of current liabilities, the company x (current ratio) of current assets. 7) Interpret a high debt to assets ratio. Debt to assets ratio measures the percentage of total financing provided by creditors rather than stockholders. This ratio means that every dollar of assets was financed by x cents of debt. 8) Define free cash flow. Free cash flow is a measurement to provide additional insight regarding a company’s cashgenerating ability. 9) Define Generally Accepted Accounting Principles (GAAP) and the characteristic “relevant”. GAAP is a set of rules and practices, having substantial authoritative support, that the accounting profession recognizes as a general guide for financial reporting purposes. Relevance: Accounting information has relevance if it would make a difference in a business decision. Information is considered relevant if it provides information that has predictive value, that is, helps provide accurate expectations about the future, and has confirmatory value, that is, confirms or corrects prior expectations. Materiality is a companyspecific aspect of relevance. An item is material when its size makes it likely to influence the decision of an investor or creditor. Chapter 3: 1) Analyze the effect of business transactions on the accounting equation. Transaction analysis is the process of identifying the specific effects of economic events on the accounting equation. On October 1, cash of $10,000 is invested in Sierra Corporation by investors in exchange for $10,000 of common stock. (Cash +10,000 and Common Stock +10,000) On October 1, Sierra borrowed $5,000 from Castle Bank by signing a 3month, 12%, $5,000 note payable. (Cash +5,000 and Notes Payable +5,000) On October 2, Sierra purchased equipment by paying $5,000 cash to Superior Equipment Sales Co. (Cash 5,000 and Equipment +5,000) On October 2, Sierra received a $1,200 cash advance from R. Knox, a client. (Cash +1,200 and Unearned Serv. Rev. +1,200) On October 3, Sierra received $10,000 in cash from Copa Company for guide services performed. (Cash +10,000 and Revenue +10,000) On October 3, Sierra Corporation paid its office rent for the month of October in cash, $900. (Cash 900 and Expense 900) On October 4, Sierra paid $600 for a oneyear insurance policy that will expire next year on September 30. (Cash 600 and Prepaid Ins. +600) On October 5, Sierra purchased an estimated three months of supplies on account from Aero Supply for $2,500. (Supplies +2,500 and Accounts Payable +2,500) On October 9, Sierra hired four new employees to begin work on October 15. (NOT A TRANSACTION) On October 20, Sierra paid a $500 dividend. (Cash 500 and Dividend 500) Employees have worked two weeks, earning $4,000 in salaries, which were paid on October 26. (Cash 4,000 and Expenses 4,000) 2) Identify the characteristics of the doubleentry system. Each transaction must affect two or more accounts to keep the basic accounting equation in balance. Recording done by debiting at least one account and crediting another. DEBITS (Increase in cash) must equal CREDITS (decrease in cash) 3) Identify the sequence of steps in the recording process. The actual sequence of events begins with the transaction. Evidence of the transaction comes in the form of a source document, such as a sales slip, a check, a bill, or a cash register document. This evidence is analyzed to determine the effect of the transaction on specific accounts. The transaction is then entered in the journal. o It discloses in one place the complete effect of a transaction. o It provides a chronological record of transactions. o It helps to prevent or locate errors because the debit and credit amounts for each entry can be readily compared. o Chart of Accounts: listing of accounts used by a company to record transactions. o Posting: the process of transferring journal entry amounts to ledger accounts. Finally, the journal entry is transferred to the designated accounts in the ledger. o The entire group of accounts maintained by a company is referred to collectively as the ledger. The ledger provides the balance in each of the accounts as well as keeps track of changes in these balances. 4) Prepare or analyze journal entries On October 1 , Sierra issued common stock in exchange for $10,000 cash. st On October 1 , Sierra borrowed $5,000 by signing a note. On October 2 , Sierra purchased equipment for $5,000. On October 2 , Sierra received a $1,200 cash advance from R. Knox, a client, for guide services for multiday trips that are expected to be completed in the future. rd On October 3 , Sierra received $10,000 in cash from Copa Company for guide services performed in October. On October 3 , Sierra Corporation paid its office rent for October in cash, $900. On October 4 , Sierra paid $600 for a oneyear insurance policy that will expire next year on th September 30 . th On October 5 , Sierra purchased an estimated three months of supplies on account from Aero Supply for $2,500. On October 9 , Sierra hired four new employees to begin work on October 15. (NOT A TRANSACTION) On October 20 , Sierra paid a $500 dividend to stockholders. On October 26 , Sierra paid employees salaries of $4,000 in cash. 5) Identify source documents. Source documents, such as a sales slip, a check, a bill, or a cash register tape, provide evidence of the transaction. 6) Apply debit/credit rules and normal account balances. 7) Analyze account activity and calculate ending account balances. 8) Identify the purpose of a trial balance. A list of accounts and their balances at a given time. Accounts are listed in the order in which they appear in the ledger. Purpose is to prove that debits equal credits. May also uncover errors in journalizing and posting. Useful in the preparation of financial statements Limitations are: The trial balance may balance even when a transaction is not journalized, a correct journal entry is not posted, a journal entry is posted twice, incorrect accounts are used in journalizing or posting, or offsetting errors are made in recording the amount of a transaction. Chapter 4: 1) Apply the revenue recognition principle. Companies recognize revenue in the accounting period in which the performance obligation is satisfied. Prepaid: Assume Conrad Dry Cleaners cleans clothing on June 30, but customers do not claim and pay for their clothes until the first week of July. The journal entries for June and July would be: 2) Calculate net income using the accrual basis of accounting. AccrualBasis Accounting o Transactions recorded in the periods in which the events occur. o Revenues are recognized when services performed, even if cash was not received. o Expenses are recognized when incurred, even if cash was not paid. Suppose that Fresh Colors paints a large building in 2013. In 2013, it incurs and pays total expenses (salaries and paint costs) of $50,000. It bills the customer $80,000, but does not receive payment until 2014. 3) Identify why adjusting entries are needed and analyze the impact of not making adjusting entries. Ensures that the revenue recognition and expense recognition principles are followed. Is required every time a company prepares a financial statement. It includes one income statement account and one balance sheet account. Never includes cash. Some events are not recorded daily because it is not efficient to do so. Examples are the use of supplies and the earning of wages by employees. Some costs are not recorded during the accounting period because these costs expire with the passage of time rather than as a result of recurring daily transactions. Examples are charges related to the use of buildings and equipment, rent, and insurance. Some items may be unrecorded. An example is a utility service bill that will not be received until the next accounting period. Types of Adjusting Entries: Deferrals: o Prepaid expenses: Expenses paid in cash and recorded as assets before they are used or consumed. Increase (a debit) to an expense account and a decrease (a credit) to an asset account. (Insurance, supplies, advertising, rent, equipment, and buildings). o Unearned revenues: Cash received before service are performed. Decrease (a debit) to a liability account and increase (a credit) to a revenue account. (Rent, airline tickets, magazine subscriptions, and customer deposits). Accruals: o Accrued revenues: Revenues for services performed but not yet received in cash or recorded. Increases (debits) an asset account and increases (credits) a revenue account. (rent, interest, and services performed) o Accrued expenses: Expenses incurred but not yet paid in cash or recorded. Increases (debits) an expense account and increases (credits) a liability account. (rent, interest taxes, and salaries). 4) Prepare adjusting journal entries. Prepaid Expenses: o Sierra Corporation purchased supplies costing $2,500 on October 5. Sierra recorded the purchase by increasing (debiting) the asset Supplies. This account shows a balance of $2,500 in the October 31 trial balance. An inventory count at the close of business on October 31 reveals that $1,000 of supplies are still on hand. o On October 4, Sierra Corporation paid $600 for a oneyear fire insurance policy. Coverage began on October 1. Sierra recorded the payment by increasing (debiting) Prepaid Insurance. This account shows a balance of $600 in the October 31 trial balance. Insurance of $50 ($600 ÷ 12) expires each month. o For Sierra Corporation, assume that depreciation on the office equipment is $480 a year, or $40 per month. Unearned Revenue: o Sierra Corporation received $1,200 on October 2 from R. Knox for guide services for multiday trips expected to be completed by December 31. Unearned Service Revenue shows a balance of $1,200 in the October 31 trial balance. From an evaluation of the service Sierra performed for Knox during October, the company determines that it has earned $400 in October. Accrued Revenues: o In October, Sierra Corporation performed guide services for $200 that were not billed to clients before October 31. Accrued Expenses: o Sierra Corporation signed a threemonth note payable in the amount of $5,000 on October 1. The note requires Sierra to pay interest at an annual rate of 12%. o Sierra Corporation last paid salaries on October 26; the next payment of salaries will not occur until November 9. The employees receive total salaries of $2,000 for a five day work week, or $400 per day. Thus, accrued salaries at October 31 are $1,200 ($400 x 3 days). 5) Define depreciation. Buildings, equipment, and motor vehicles (longlived assets) are recorded as assets, rather than an expense, in the year acquired. Companies report a portion of the cost of a longlived asset as an expense (depreciation) during each period of the asset’s useful life. Depreciation does not attempt to report the actual change in the value of the asset. 6) Identify the characteristics of the adjusted trial balance. After all adjusting entries are journalized and posted the company prepares another trial balance from the ledger accounts (Adjusted Trial Balance). The adjusted trial balance’s purpose is to prove the equality of debit balances and credit balances in the ledger. The adjusted trial balance is the primary basis for the preparation of the financial statements. Financial statements are prepared directly from the Adjusted Trial Balance. (Income statement, Retained Earnings Statement, and Balance Sheet). 7) Identify the purpose of closing entries. The purpose of the postclosing trial balance is to prove the equality of the permanent account balances that the company carries forward into the next accounting period. All temporary accounts will have zero balances. 8) Calculate the retained earnings balance after closing entries.
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