Study Guide Exam 1
Study Guide Exam 1 ACC 3305-02
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This 22 page Study Guide was uploaded by Jamie Douglas on Wednesday September 21, 2016. The Study Guide belongs to ACC 3305-02 at Baylor University taught by Mrs. Abbe in Fall 2016. Since its upload, it has received 77 views. For similar materials see Intermediate Accountng in Accounting (ACCT) at Baylor University.
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Date Created: 09/21/16
** I MADE A QUIZLET : https://quizlet.com/_2g4dak Chapter 1: Errors caught by trial balance: 1 record wrong amount as a debit when it should be a credit or credit when it should be a debit 2 record 2 debits without a credit Errors NOT caught by trial balance: 1 recording wrong amount as both the debit and credit 2 record or post to the wrong account (example: customer makes payment on account and you debit cash and credit accounts payable wrong! You need to debit cash and credit accounts receivable) 3 failed to record or post a transaction Accounts that require adjusting entries: Short term investments Account receivable ( allowance acct is adjusted) Deferred taxes Long term marketable Property, plant, and equipment Acquired tangible assets Accounts payable Accrued expenses Deferred revenue Chapter 1 handout: Financial accounting: identification, measurement, and communication of financial information about economic entities to interested parties ( focus on external parties) Financial Statements: Income Statement Revenues Expenses= Net Income ** Covers a period of time** Statement of Comprehensive Income: reporting all the items that may not fall under net income Net Income + other comprehensive income = total comprehensive income Other comprehensive income includes things that go straight to equity Balance Sheet Assets=Liabilities + S/E ** Snapshot of financial position at a moment in time Statement of Cash Flows reflects amounts and sources of cash inflows, as well as uses of cash outflows 3 categories: Operating expenses Investing expenses Financing expenses Objective of Financial Reporting: Provide information useful for investing(investors) and lending(creditors) decisions (focus on decisions usefulness for assessing future cash flows and stewardship ** Financial reporting facilitiates effiicient allocation of capital throughout global economy ** Limitations of financial reporting: 1. Estimates bad debts, depreciation, warranty expense, income tax expense, goodwill, etc. ( matching principle requires estimates) 2. Does not include many important nonfinancial measurements or soft assets: innovation, competitors, negative press, human resources, product quality, customer service. 3. Lack of timeliness historical data GAAP set of standards and procedures used to prepare financial statements (provides comparability and consistency) Source of written GAAP: Financial accounting standards board (FASB) issued Statements of Financial Accounting Standards until 2009; now issues Accounting Standard Updates (ASU’s) and Statements of Financial Accounting Concepts. FASB is a privately funded organization ** it can take months or even years for FASB to decide standards** ● GAAP is not determined in a vacuum result of political influences ( those who may experience negative economic consequences may lobby to stop changes (ex: expensing stock options )) Role of SEC They have significant influence and authority over financial reporting for ALL public companies; generally supports standards developed by FASB ( SEC has ultimate authority) International accounting: ● Reporting standards differ among countries because objectives of financial reporting differ ● The primary users of financial statements in many IFRS countries are private investors, tax authorities, and central government planners. In the US, investors and creditors have driven accounting standard formulation ● Many countries (approx. 120) adhere to IFRS rather than GAAP IFRS stands for International Financial Reporting Standards Developed by IASB (International Accounting Standards Board) Possible convergence of U.S. GAAP with IFRS ● SEC will allow public companies at least 4 years to adjust if it decides to mandate IFRS ● Currently, the FASB and IASB continue to work on convergence projects IFRS considered more principlesbased than GAAP. GAAP is considered more rulesbased ( not as much flexibility with GAAP) Chapter 3: What is a journal? A record of financial transactions by date What is a ledger? Account or record that is used to store balance sheet and income statement transactions Contains book of all the accounts Used to prepare financial statements and trial balance What is it meant by posting? When balances in the journal are shifted into the general ledger Transferring debits and credits from journal to ledger Normal Balances: Asset accounts: Debit Liabilities accounts: Credit Permanent Stockholders equity accounts: Common Stock Credit Paid in Capital in Excess of Par Credit Retained Earnings Credit Treasury Stock (contra equity) Debit Temporary Stockholders’ equity accounts:** can never have anything other than their normal balances** Revenue accounts Credit Expense accounts Debit Dividends Debit CashBasis Accounting Record revenue when cash is received from customers and record expenses when cash is paid ** NOT permitted by GAAp AccrualBasis Accounting Record revenue when earned ( when goods or services are delivered to customers) and record expenses in the period in which they are incurred Additional GAAP: Revenue recognition principle: record revenue when a performance obligation has been satisfied( aka when the goods or services have been delivered to the customer) (based on a new accounting standard) Expense recognition (matching principle) expenses should be recorded in the period that the asset is used up ( match expenses to the revenues they help generate; includes systematic and rational allocation of expenses which cannot be directly matched to revenues) TimePeriod Concept a company’s activities can be divided into artificial time periods for financial reporting purposes; ensures that accounting information is reported at regular intervals (most common =1 year); justification for the need for adjusting entries Accounting cycle: 1. Journalize 2. Posting (t accounts) 3. Trial Balance proves equality of dollar amount of debits and credits ( not a formal financial statement; its prepared from the ledger and is an internal control tool) 4. Adjusting Entries ( journalize and post) 5. Adjusted trial balance 6. Financial Statements 7. Closing Entries ( journalize and post) 8. Postclosing Trial Balance ( only have permanent accounts) Adjusting Entries: 1. Purpose: a. To record revenues earned and expenses incurred that did not get recorded during normal operations ( ex: baylor bills you before classes start) b. To update balance sheet accounts before preparing financial statements (ex: supplies) 2. Always recorded on last day of accounting period 3. Every AJE includes a revenue or expense and an asset or a liability ( every AJE affects BOTH the balance sheet and income statement) 4. NEVER record Cash in an AJE Closing Entries: 1. Purpose: to reduce the balance of temporary accounts to zero 2. * update balance of retained earnings* a. Accounts that get closed: all temporary accounts (revenues, expenses, dividend accounts, losses, gains) (includes all income statement accounts and dividends because they reduce retained earnings) The permanent accounts are all the accounts found on the balance sheet ( they never get closed, their balances carry over) 3 Closing entries: Close revenues and gains (debit each revenue account to close it and credit retained earnings) Close expenses and losses (credit to close them and debit retained earnings) Close dividends (debit retained earnings and credit dividends) What is meant by the term book value with respect to a plant asset? It is the original cost minus depreciation. Depreciation is an allocation concept, not a valuation concept. What kind of account is unearned service revenue? What journal entry is made when this account is reduced? Unearned service revenue is a liability account. It is a liability account because a company has a performance obligation to provide service to one of its customers Debit unearned service revenue Credit service revenue What is an accrued expense? Accrued expenses are expenses incurred but not yet paid or recorded at the statement date ( ex: interest) What is an accrued revenue? Accrued revenue is revenues for services performed but not yet recorded at the statement date Chapter 4: How is gross profit computed: RevenueCOGS=gross profit 3 examples of operating expense: Insurance costs, legal fees, property taxes What is a discontinued operation? Discontinued operation occurs when a segment or certain product line has been sold, disposed of or no longer being used. It is kept separate from continued operations. Example: Sale of an entire division. Income or loss from a component that has been disposed of ( a component is any product or segment group whose operations and cash flows can be clearly distinguished from the rest of the company) Usefulness of the Income Statement: Income information is useful: For evaluating past performance of a company For predicting future performance For determining the risk (uncertainty) of achieving future cash flows. Information about the various components of income revenues, expenses, gains, and losses is helpful for assessing the likelihood that particular cash flows will continue in the future Limitations of the incomes statement: 1) Omits items that can’t be measured but contributes to company wealth (ex: brand name, unique technology, customer satisfaction, superior R&D) 2) Accounting methods may differ (ex: lifo vs. fifo, straightline method vs. DDB(ddb= double declining balance) 3) Judgement and estimates useful life, percentage used to estimate bad debts, warranty expense, ect. Earnings management planned timing of revenues, expenses, gains, and losses to achieve a particular income result or earnings trend; decreases the quality of earnings ( makes information less useful for predicting future earnings and cash flows Elements of income statement: revenues, expenses, gains, and losses Pro Forma Income Statements: “asif” income statements Adjust income or exclude item that the company believes are not representative of operation results Items often excluded includes: restructuring charges, amortization expense, impairment losses, stock based compensation. SingleStep income statement groups all revenues together and all expenses together Selling expenses sales salaries, advertising, delivery, warranty expense, bad debts, depreciation of sale office equipment Administrative expenses office salaries, executive salaries, utilities, rent, insurance, office supplies, depreciation of office equipment MultipleStep income statement separates operating and nonoperating activities and reflects several important subtotals Nonoperating activities includes interest revenue, gain on sale of land, interest expense, restructuring charges, loss on sale of equipment, loss on litigation Irregular (“belowtheline”) Item: Discontinued operations: disposals representing a strategic shift in operations that have a major effect on the organization’s operations and financial results will be required to be presented as discontinued operations. Examples cited by FASB include disposals of the following: a major geographic area; a major line of business; and a major equity method investment a) Shown in two parts: 1) Income (loss) on operations, net of tax 2) Gain (loss) on disposal, net of tax b) Shown net of tax: Income (loss), net of tax= income (loss) * (1tax rate) Other irregular items: 1. Unusual items usually reported as “other revenues and gains” or “other expense and losses” on the income statement NOT shown net of tax i. Ex: gain on sale of land, loss on sale of building, loss from litigation, impairment loss, gain on sale of investments, restructuring charges( closing costs, etc.), loss from inventory writedown, interest revenue, interest expense 2. Noncontrolling Interest (applicable to consolidations) portion of equity (net assets) interest in the subsidiary not attributable to the parent. Reported as separate item below net income or loss as an allocation of the net income or loss (not an item or expense) 3. Change in accounting principle (also known as CAP) ( like changing inventory) change in accounting method (ex: change from average cost to FIFO) or adoption of new accounting principle( ex: stock options expensed) Cumulative effect of change for prior periods is reported as adjustment to beginning Retained Earnings on the Statement of Retained Earnings ( does NOT flow through the income statement) Shown net of tax ( you determine net of tax amount) Retroactive adjustment to financial statements presented (restate prior years’ financial statements as if new method had been used all along)< allows analysts to properly compare the financials and can make projection going forward) 4. Change in Estimate ex: change in useful life or salvage value, change in percentage used to estimate bad debts, change from straightline to DDB, etc.. No retrospective adjustment (never go back and change prior years) Accounted for only in current and future periods ** new info leads us to believe a change in useful life * Only current and future years are affected. Important to disclose in the footnotes. Prior Period Adjustments (PPA) correction of errors made in previous accounting periods; adjustment to beginning Retained Earnings (net of tax) of the earliest year presented ** it’s made in a period where we’ve already closed the books; must restate prior years financial statements for corrected error** Tax allocation process of associating income tax expense with related income ● Income from continued operations ( income tax expense) ● Discontinued operations (shown net of income tax) Earnings Per Share (EPS) Net income minus preferred dividends divided by weighted average number of common shares outstanding(shares issuedtreasury shares) *** know this formula** Disclosed on income statement for: Income from continuing operations Net income Ex: alpha had 2015 net income of $1,200,000 and declared preferred dividends of $200,000. The weighted average number of common shares outstanding was $160,000. So… EPS= 1,200,000200,000/160000 shares = $6.25 per share Statement of Retained Earnings: Beginning retained earnings +/ CAP, net of tax +/ PPA, net of tax Adj. begin balance + Net income Dividends End R/E Comprehensive Income: **anything on income statement is comprehensive income** All changes in stockholders equity during the period except investments by owners and distributions to owners (doesn’t include issuance of stock or dividends, or paid to stockholders or purchase of treasury stock) Consists of: 1) Net income 2) Other comprehensive income (OCI) non owner changes in equity that bypass net income, but affect stockholders equity. Example: unrealized gains/losses on certain securities and certain hedge transactions Example:Certain foreign currency translation gains/losses Summary of Expense Recognition Principles: When are expenses recognized? ideally , expenses are reported on the statement of earnings at the same time that the related revenue is recognized ( this is the socalled matching principle). However, because it is often difficult to relate specific expenses to specific revenues, expenses generally are recognized according to whichever of the following three expense recognition methods seem most appropriate: 1) Associating cause and effect some assets are used up as a direct result of making a sale, the most obvious examples being merchandise inventory and cash consumed to pay delivery charges. Accordingly, the costs of assets used up as a direct result of making a sale are recognized as expenses at the same time ( meaning in the same reporting period) that the related sales revenue is recognized. (example: COGS, Delivery expense, warranty expense, bad debt expense) a) In addition to the assets used up as a direct result of the sale, the act of making a sale often creates an obligation on the part of the enterprise to deliver cash or provide goods or services to another entity (usually the buyer) at some date after the date of sale. Examples include cash rebates owed to buyers, obligations to make repairs under product warranties, and sales commissions owed to salespersons ( here the obligation is to an employee or an agent). For those obligations that are created by a sale, the amount of the obligation is recognized as an expense at the same time (meaning in the same reporting period) that the related sales revenue is recognized. i) By recognizing expenses at the same time as the related revenue is recognized, the expenses are said to be recognized by associating cause and effect. Expenses recognized by associating cause and effect follow the matching principle more closely that do expenses recognized according to “systematic and rational allocation” or “immediate recognition” 2) Systematic and rational allocation (examples: depreciation, amortization, supplies, prepaid accounts) Some assets are not used up as a direct result of a specific sale but, instead, provide benefits to the enterprise over an extended period of time. In such cases, the cost of the asset is recognized as an expense over several reporting periods in a systematic manner that corresponds to the pattern by which the benefits expire. 3) Immediate recognition (research and development, training, etc.) For goods and services acquired by the enterprise whose benefits expire in full at approx. the same time as acquired or shortly thereafter (examples include salaries and wages of admin personnel, cost of janitorial expenses, etc.) a) Some goods and services have potential future benefits but the period and pattern of benefits are not reliably determined. For these, their cost is recognized as an expense at the time the goods or services are acquired. ( examples include cost of research and development, cost of most advertising campaigns and most training programs. b) Some costs are incurred by an enterprise for which the enterprise receives no discernible benefits. These include income taxes, charitable contributions, litigation damages, and fines. By GAAP these are recognized as expenses or losses when incurred ( immediate recognition) c) Immaterial items are expensed as incurred (immediate recognition) Chapter 5 Define current liabilities: obligations a company reasonably expects to liquidate either through use of current assets or creation of other current liabilities. You don’t want a large amount here. It’s not just debts within the year. How is working capital calculated: current assetscurrent liabilities What is the difference between unappropriated retained earnings and restricted retained earnings? ● Unappropriated = the amount usually available for dividend distribution ● restricted=bond indentures or other loan agreements Describe the three levels of fair value hierarchy used for valuing financial instruments: ● Level 1 measures are based on observable inputs, such as market prices for identical assets/liabilities. (it is the least subjective and most objective) ● Level 2 measures are based on marketbased inputs other than those included in level one. (more subjective, less objective) ● Level 3 measures are based on unobservable inputs, such as a company’s own data or assumptions (most subjective, least objective, least reliable) Uses of a balance sheet: 1. To provide information related to: ○ Liquidity: the amount of time until an asset is realized or otherwise converted into cash. ○ Financial: the ability of an enterprise to take effective action to alter the amounts and timing of cash flow. 2. Aids in assessing risk and predicting future cash flows. Limitations of a balance sheet: 1. Failure to reflect current value information (most numbers are based on historical costs) 2. Judgments and estimates (goodwill requires estimating, A/R less allowances) 3. Failure to include items of financial value that cannot be recorded objectively. Ex: human resources, managerial skills, customer base, and reputation, leases and certain contractual arrangements are reported in an “off balance sheet” (ex: apple’s trade symbol isn’t measurable) Balance sheet classifications: A. Assets probable future economic benefits ● Current assets cash and other assets expected to be converted into cash, sold, or consumed either in one year or in the operating cycle, whichever is longer; presented in order of liquidity ○ Cash and cash equivalents: cash, petty cash, bank deposits, cashiers checks, cash equivalent shortterm liquid investments that mature < or equal to 3 months, money market funds, cd’s, commercial paper, etc. ) ○ Shortterm investments: Equity securities reported at fair value *unless ownership >20% Unrealized gains (losses) from adjusting to fair value are reported on the income statement. May be reported as current assets or longterm investments depending on the management’s intent Debt securities classified in one of three categories: ● Trading these are debt securities that you will sell quickly. They are ones management intends to sell in shortterm to maximize profits ○ Reported as FMV on the balance sheet ( unrealized gains and losses from these go in the income statement) ○ Always a current asset ● Heldtomaturity debt securities in which management intends to hold until maturity ( what it’s worth isn’t relevant. ○ Reported as amortized cost ( carrying value moves to face value) ○ Longterm asset unless maturity is 1 year or less, then its a current asset. ● Availableforsale reported at FMV (fair market value). (unrealized gains or losses are reported as other comprehensive income ○ Debt securities which are not trading or heldtomaturity ○ May be a current asset or longterm asset depending on management’s intent. (view with a healthy degree of skepticism) ○ Receivables reported at net realizable value (NRV) NRV is what the company expects to collect ○ Inventories reported at lowerofcost or NRV, valuation method must be disclosed. ○ Prepaid expenses: ex: supplies, prepaid rent, prepaid insurance, advances to suppliers. ● Noncurrent assets ○ Longterm investments key is that management intent is to hold these investments for an extended period of time. 1) Investments in securities (AFS or HTM) 2) Investments in tangible fixed assets not currently used in operations: land held for speculation (ex: land held for a future plant site) 3) Investments set aside in special funds: sinking funds, pension funds, plant expansion funds (plant expansion falls under investments) 4) Investments in nonconsolidated subsidiaries or affiliated companies ○ Property, Plant, and Equipment tangible physical property such as land, buildings, machinery, furniture, and “wasting resources” (timberland minerals) used in operations ex: buildings, machinery, land, equipment, furniture, automobiles (** if it’s here, we’re using it) under GAAP it is reported as costacc.depreciation=book value ○ Intangible assets resources that lack physical substance but provide economic rights and advantages ex: patents, franchises, copyrights, goodwill, trademarks, licenses, customer lists,... ( no current substance: also reported at book value (aka costacc. depreciation) ○ Other Assets a catch all category REMEMBER!! Proper classification of assets depends on both the nature of the item and the use. For example: Land used as a factory site classify as property, plant, and equipment Land owned by a realty company and held for sale classify as current asset (inventory) Land held for speculation classify as longterm investment Idle land and facilities withdrawn from production classify as investment or other assets. ● Liabilities probable future sacrifices of economic benefits ○ Current liabilities obligations that are reasonably expected to be liquidated through the use of current assets or the creation of other current liabilities within one year or operating cycle, whichever is longer. Ex: Accounts Payable, salary payable, interest payable, unearned revenue, warranty payable, taxes payable, current portion of longterm debt ● *** some liabilities that will be paid in a year still need to be considered a long term liability. These include: shortterm debt expected to be refinanced, debt that will be retired out of noncurrent assets. ○ Longterm liabilities obligations that are reasonably expected to be liquidated at some date beyond one year or one operating cycle. Ex: bonds payable, mortgage payable, lease obligations, deferred tax liability, pension liability… ■ With regards to bonds, any premium or discount on bonds payable is disclosed separately as an addition to or subtraction from the bond. Theoretically, any premium or discount related to the current portion of LT bonds should also be reclassified as current. ■ ** premiums and discounts are always with the bond. If the bond is current, the premium or discount is current also** ● Equity ○ Capital stockcarried at the par or stated value of the shares issued; amounts above par or stated value are recorded in PIC accounts ■ *** the authorized, issued, and outstanding par value amounts must be disclosed. Treasury stock is shown as a reduction of stockholders’ equity. (Treasury stock is a contra equity account so it is a reduction) ○ Retained earnings each year income is closed into retained earnings. Retained earnings are reinvested into the company. It doesn’t mean it’s all in cash. ■ Appropriated (restricted) not available for dividend distribution (typically based on loan agreements, etc.) ● Amount restricted must be disclosed in the footnotes ■ Unappropriated available for dividend distribution ○ Accumulated other Comprehensive Income ■ Other comprehensive income (loss) is closed into accumulated OCI Additional Information: Contingencies: things that could result in a potential liability ( litigation charges) Accounting policies: should ALWAYS be in the footnotes Contractual situations purchase commitments ( not on balance sheet but have to fulfill it) Fair values since it’s not objective
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