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ALBANY / Engineering / BACC 211 / A sole proprietorship means what?

A sole proprietorship means what?

A sole proprietorship means what?

Description

School: University at Albany - State University of New York
Department: Engineering
Course: Financial Accounting
Professor: Professor
Term: Spring 2020
Tags: financial accounting and Accounting
Cost: 50
Name: BACC 211: Financial Accounting Exam 1 Study Guide
Description: This is a detailed study guide for Exam 1 covering Chapters 1-4.
Uploaded: 03/01/2020
10 Pages 18 Views 10 Unlocks
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Klaudia Rogala


A sole proprietorship means what?



BACC 211 Financial Accounting Exam 1 Study Guide (Chapters 1-4)

Chapter 1: Financial Accounting and Business Decisions 

Forms of business ownership: 

• Sole Proprietorship

o Owned by one person that personally assumes legal responsibility

o Most common type of organization

o Life is limited by the participation of owners (death or withdrawal, whichever  comes first)

o Tax advantage: income of business is not taxed, only taxed as owner’s income • Partnership

o Group of people that assume legal responsibility coming together to conduct  business

o Life is limited by the participation of owners (death or withdrawal, whichever  comes first)


A partnership means what?



o Tax advantage: income of business is not taxed, only taxed as owner’s income o Multiple partners bring broader skill set

• Corporation

o Legal entity distinct from its one or more owners, protected from personal  liability

▪ Ex: In a lawsuit, damages will be charged against corporation, not  

individuals; their personal assets remain intact and corporation will use  money until bankruptcy to pay damages. Don't forget about the age old question of What is a hematocrit?

o Pay taxes on business profit, and again on dividends (remaining profits after  taxation)⇒double taxation

o Unlimited life until formally dissolved

Business Activities 


A corporation means what?



• Financing

o A company needs to acquire money to support operations

o Debt financing: involves borrowing money from bank by signing note payable or  from investor by an issue of bonds payable Don't forget about the age old question of What is the definition of stenosis?
Don't forget about the age old question of Who explores the louisiana purchase lands?

▪ Creditor: those money is borrowed from who expect return with interest o Equity financing: involves selling shares of stock to investors

• Investing

o Process of acquiring assets (objects company owns that can be converted into  cash) to conduct business

• Operating

o Day-to-day activities of producing and selling a product or service

1

Accounting Information and Its Use 

• External Users: parties outside company who want to know about it (e.g. potential  investors, creditors, stockholders)

o Potential investors want to compare prospective investments to determine if  they should invest

o Creditors want to consider financial strength of company before giving loans o Stockholders want to evaluate if they should invest more or sell shares o Financial accounting: the process of mining financial information for external  users

• Internal Users: parties inside company who want to know about it (e.g. management) o Want to know cost of products, estimates of income to be generated, etc. o Managerial accounting: the process of mining financial information to provide  information for internal users We also discuss several other topics like What is a veneer?

• Financial information provided in financial statements must be in conformity with  Generally Accepted Accounting Principles (GAAP), a set of standards and procedures  that guide the preparation of financial statements, in order to be deemed reliable

Financial Accounting Oversight 

• The Financial Accounting Standards Board (FASB) 

o Sets accounting principles

• U.S. Securities and Exchange Commission (SEC)

o An independent agency of the U.S. federal government responsible for enforcing  the federal securities laws, and regulating the securities industry

• Public Company Accounting Oversight Board (PCAOB) 

o A quasi-governmental agency established by the Sarbanes-Oxley Act that  approves Generally Accepted Auditing Standards (GAAS), inspects the work of  accounting firms, and disciplines independent auditors that fail to meet and  maintain acceptable standards of audit performance

• International Accounting Standards Board (IASB)

o An independent accounting standard-setting agency whose purpose is to  develop the International Financial Reporting Standards (IFRS) We also discuss several other topics like When was the neolithic age happened?

4 Financial Statements (in order of preparation) We also discuss several other topics like In which way does sex differ from gender?

1. Income Statement: a financial statement that lists a business’ sales revenue and  expenses for a given period of time

o Period-in-time statement: accumulates information for a specific time period  (e.g. 1/1/17-12/31/17)

o Sales revenue = increases in stockholders’ equity that result when a firm  provides goods or services to its customers

o Expenses = decreases in stockholders’ equity incurred by a firm during the  process of generating its sales revenues (e.g. cost of goods sold, selling expense,  interest expense, etc.)

o The final item in an income statement is net income (profit) or net loss

2

▪ Total Revenue = Revenue – Expenses

▪ Revenue > Expenses, resulting amount is net income

• NI = Rev - Exp

▪ Expenses > Revenue, resulting amount is net loss

2. Statement of Stockholders’ Equity: a financial statement presenting information  regarding the events that cause a change in stockholders’ equity during a period o Period-in-time statement

o Consists of contributed capital and earned capital/retained earnings ▪ Contributed capital: the capital contributed to a company by stockholders  when they purchase shares of stock from the company

▪ Earned capital/retained earnings (RE): capital that is earned by a  

company and not distributed to its stockholders as a dividend

▪ RE(for year) = NI – Dividends

▪ RE(end of year) = RE(beginning of period) + RE(for year)

3. Balance Sheet: a financial statement showing a business’ assets, liabilities, and  stockholders’ equity as of a specific date

o Point-in-time statement: presents information as of a particular date (e.g.  12/31/2017)

o Liabilities: the obligations or debts that a business must pay in money or services  at some time in the future as a consequence of past transactions or events o Stockholders’ equity: the residual interest in the assets of a business after all  liabilities have been paid off

o Accounting Equation

▪ Assets (resources of a company) = Liabilities (creditor claims on  

resources) + Stockholders’ equity (owner claims on resources)

• A = L + SE

• SE = A – L

• A – L = Net assets

• SE = Net assets

4. Statement of Cash Flows: a financial statement showing a firm’s cash inflows and cash  outflows for a specific period

o Period-in-time statement

o Cash flows are grouped into three business activities: operating, investing, and  financing (see ‘Business Activities’ p.1)

▪ Cash flows from operating activities include cash received from goods  and services sold and cash spent on operating expenses

▪ Cash flows from investing activities include cash payments and receipts  from business’ purchase of assets used in operations

▪ Cash flows from financing activities include the issuance and repurchase  of the business’ own shares and the amounts borrowed and repaid to  creditors

▪ Positive numbers on statement represent sources of cash

▪ Negative numbers on statement represent uses of cash (negative  

numbers are represented by parentheses)

3

• 4 financial statements provide key information for the Form 10-K, an annual report sent  to a company’s shareholders

• Components of Form 10-K:

o Notes to the financial statements provide a description of the assumptions and  estimates that were used in preparing the statements, the measurement  procedures that were followed, and the details behind the summary numbers

o The auditor’s report includes an opinion about the representation of the  company’s financial health and if the financial statement was prepared in  accordance with GAAP (see ‘Accounting Information and Its Use’ p.2)

o The Management Discussion and Analysis (MD&A) contains an interpretation of  company’s recent performance and financial standing and a discussion of  possible future opportunities and risks

Accounting Skills 

• Data analytics: examining data to discover important information from patterns • Blockchain technology: a digital ledger (a collection of financial accounts) that provides a  secure way to view recorded transactions

Chapter 2: Processing Accounting Information 

The Accounting Cycle 

1. Analyze

o Use the accounting equation (A = L + SE) to summarize company’s data and  transactions

▪ SE includes Common Stock and Retained Earnings

▪ Retained Earnings = Revenues – Expenses - Dividends

o Accounting transaction: an economic event that must be recorded in the company’s  accounting records that result in a change in assets, liabilities, or stockholders’  equity (e.g. paying wages to employee)

▪ Affects at least 2 elements of the accounting equation so that both sides  are equal⇒double-entry accounting: a method of accounting that results in  the recording of equal amounts of debits and credits

▪ Event: activity undertaken by a business, not necessarily economic (e.g.  hiring employee)

2. Record

2.1. Identify evidence of a business transaction in the form of a source document: any  written document or computer record that evidences an accounting transaction (e.g. invoice, receipt, bank check, deposit slip)

2.2. Determine the T-accounts affected (see ‘The Account System’ p.5) and journalize, or  write out a journal entry, in the general journal: an accounting record in which business  transactions are analyzed in debit and credit terms and recorded in chronological order ▪ Debit transactions appear in the first row

▪ Credit transactions appear in the second indented row

4

▪ The sum of debit amounts must be equal to the sum of credit accounts ▪ Compound journal entry: a journal entry involving more than 2 accounts 2.3. Post journal entries to general ledger

▪ Posting: transferring the debit and credit information from the general  journal to the general ledger

▪ General ledger: a grouping of all of a business’ accounts that are used to  prepare the basic financial statements

▪ Use posting reference code (the number in parentheses next to the debit or  credit amount) to be able to trace entry in general ledger to general journal 3. Adjust

4. Report

5. Close

The Account System 

▪ Chart of accounts: a list of all the general ledger account titles (listed in the order they  appear below) and their numerical code

o 6 primary categories of accounts

▪ Assets

▪ Liabilities

▪ Stockholders’ Equity

▪ Revenues

▪ Expenses

▪ Dividends

o Can be narrowed down into 4 categories:

▪ Assets

▪ Liabilities

▪ Revenue

▪ Expense

▪ T-account: an abbreviated form of the formal account in the shape of a T consisting of  the account title (e.g. cash), the amounts reflecting decreases and increases, and cross reference to other accounting records (numbers are used to identify transactions) o Debit accounts appear on the left side

▪ Assets, expense, and dividends increase with debit entries (normal  

balance)

▪ Liabilities, Stockholders’ equity, Common stock, retained earnings and  revenue decrease with debit entries

o Credit accounts appear on the right side

▪ Assets, expense, and dividends decrease with credit entries

▪ Liabilities, Stockholders’ equity, Common stock, retained earnings and  revenue increase with credit entries (normal balance)

o Normal balance: the side on which increases to the account are recorded o Revenue, expense, and dividends are temporary subdivisions of retained  earnings

5

o T-account balance is computed by summing the numbers in each column (debit  and credit side) and subtracting the smaller total from the larger total. Balance is  placed on the side of the larger total.

Chapter 3: Accrual Basis of Accounting 

Accounting Principles 

• Cost principle: an accounting principle stating that asset and liability measures should be  recorded on the balance sheet at the price paid

• Revenue Recognition principle: sales revenue should be recorded when services are  performed or goods are sold and delivered

o Revenue earned before cash is received results in debiting Accounts Receivable  (Asset account) and crediting Sales Revenue (Stockholders’ equity/revenue  account)

o Revenue earned after cash is received results in debiting Cash and crediting  Unearned Revenue (liability account)

• Expense Recognition (Matching) principle: all expenses incurred to generate revenue for  a period must be matched with revenue for that period

• Full disclosure principle: an accounting principle stating that all facts necessary to make  financial statements useful should be disclosed in a firm’s annual report

If you see the word:

o payable after an account, it is a liability account (e.g. accounts payable, notes  payable)

o unearned before an account, it is a liability account (e.g. unearned revenue) o expense after the account name, it is an expense account. In addition, ‘Cost of  Goods Sold’ is also an expense account.

o revenue after the account name, it is a revenue account (e.g. sales revenue a/c,  rent revenue a/c, interest revenue a/c)

o All other accounts are typically asset accounts

The Accounting Cycle Continued 

1. Analyze

2. Record

3. Adjust

3.1. Prepare unadjusted trial balance: a list of the account titles from the general ledger,  their respective debit or credit balances, and the totals of the debit and credit balances before adjustments have been made

- Serves as a check on whether the totals of the debit and credit balances are equal, if  not there is a recording error present

- Even if sums are equal, there could still be an error in accounting data due to  transactions that were not journalized or journal entries that were not posted,  posted but in the wrong amount, or posted but in the wrong accounts

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- Prepared at the end of the period prior to preparation of financial statements 3.2. Make adjustments

• Types of adjustments:

Deferrals: adjustments that allocate various assets and revenues received in  advance to the proper accounting periods as expenses and revenues (i.e. prepaid  expenses and unearned revenues); deals with amounts that have previously  been recorded in a balance sheet

o Unearned revenue: liability account for when a business receives fees for  services or products before the services or products are rendered

(provided)

▪ Before rendering: Debit cash account and credit unearned  

revenue account

▪ Adjustment entry after rendering: Debit unearned revenue  

account and credit revenue account

▪ Failure to adjust for unearned revenues will result in an  

understatement of revenue and stockholders’ equity and an  

overstatement of liabilities

o Depreciation: the process of allocating the cost of buildings, equipment,  and vehicles to expense over the time periods benefitting from their use

▪ Depreciation expenses are prepaid expenses that are recorded in  

a contra account (accounts grouped together with similar nature  

but different normal balance) called Accumulated Depreciation,  

an asset account. The adjusting entry made is debiting the  

depreciation expense account and crediting the accumulated  

depreciation account.

▪ Failure to adjust for prepaid expenses will result in an  

overstatement of assets and stockholders’ equity and an  

understatement of expenses

Accruals:

o Accrued revenues: adjustments that reflect revenues earned but not  received or recorded

▪ Adjusting entry: debit expense account and credit liability account

▪ Failure to adjust for an accrued revenue will result in the  

understatement of assets, revenue, stockholders’ equity and net  

income

o Accrued expenses: adjustments that reflect expenses incurred but not  paid or recorded

▪ Adjusting entry: debit asset account and credit revenue account

▪ Failure to adjust for an accrued expense will result in the  

understatement of expenses and liabilities and an overstatement  

of stockholders’ equity and net income

4. Report

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• Prepare financial statements in following order using adjusted trial balance: a list of  general ledger accounts and balances prepared after adjustments have been made 1. Income Statement (see ‘4 Financial Statements’ p.2)

2. Statement of Stockholders’ Equity (see ‘4 Financial Statements’ p.3)

3. Balance Sheet (see ‘4 Financial Statements’ p.3)

4. Statement of Cash Flows (see ‘4 Financial Statements’ p.3)

5. Close

5.1. Identify account as either permanent or temporary

• Permanent account: an account used to prepare the balance sheet (i.e. asset,  liability, or stockholders’ equity accounts (common stock & retained earnings)) ▪ Balance at the end of the accounting period is carried to the following  accounting period

• Temporary account: an account used to gather information for an accounting period  (i.e. revenue, expense, or dividend accounts)

▪ Balance at the end of the accounting period is transferred to retained  earnings, becomes 0⇒closing process 

5.2. Close the revenue accounts

• Credit the Retained Earnings account for the total amount of earned revenue,  and debit each revenue account for an amount equal to its current credit  balance

5.3. Close the expense accounts

• Debit the Retained Earnings account for the total amount of expenses, and  credit each expense account for an amount equal to its current debit balance 5.4. Close the dividends accounts

• Debit the Retained Earnings account, and credit the Dividends account for an  amount equal to the balance in the Dividends account

5.5. Prepare post-closing trial balance

Trend: when closing revenue, expense, and dividends accounts to Retained Earnings,  debit/credit depending on the normal balances for each individual account (referring to  revenue, expense, or dividend account).

To exemplify that, the normal balance for a Revenue Account is credit, so you would  credit Retained Earnings.

If you credited the Retained Earnings account, debit the individual account and vice versa. Chapter 4: Understanding Financial Statements 

Balance Sheet Classification and Analysis 

• Classified balance sheet: a balance sheet in which items are classified into subgroups  to facilitate financial analysis and management decision making

o Typical components:

Assets

8

▪ Current assets: cash and other assets that will be converted into cash  or used up during the normal operating cycle (average period of time  

between the use of cash to buy goods for resale or to provide services  

and the subsequent collection of cash from customers) of a business

or one year, whichever is longer

• Current assets listed in order of liquidity: the ease with which  

each of the assets can be converted into cash

▪ Noncurrent/Long-term assets: cash and other assets that will not be  

converted into cash or used up during the normal operating cycle of a  

business or one year, whichever is longer. Include:

• Plant, property, and equipment: land, buildings, equipment,  

vehicles, furniture, and fixtures a company uses in daily  

operations

• Intangible assets: an asset lacking a physical presence (e.g.  

brand names, copyrights, patents, and trademarks)

Liabilities

▪ Current liabilities: liabilities that must be settled within the normal  

operating cycle of a business or one year, whichever is longer

▪ Noncurrent/Long-term liabilities: debt obligations not due to be repaid  within the normal operating cycle of a business or one year, whichever  

is longer (e.g. deferred revenue, long-term debt)

Stockholders’/Shareholders’ equity: the residual interest in the assets of a  business after all liabilities have been paid off

▪ Contributed capital (see ‘4 Financial Statements’ p.3)

▪ Retained earnings (see ‘4 Financial Statements’ p.3)

• Two generally accepted formats for presenting a classified balance sheet: o Account form

▪ Assets are displayed on the left side

▪ Liabilities and stockholders’ equity are displayed on right side

o Report form

▪ Assets are displayed at top followed by liabilities and stockholders’  

equity

▪ More commonly used format

Income Statement Classification and Analysis 

• Single-step income statement: a simple format of the income statement where net  income is computed in one step by subtracting total expenses from total revenues • Classified/Multi-step income statement: an income statement in which one or more  intermediate performance measures, such as gross profits on sales, are derived  before the continuing income is expected

o Gross profit/gross margin = Cost of goods sold (CoGS) – net sales

▪ Cost of goods sold is the second term on income statement

9

▪ Net sales = total sales – estimate of sales returns and allowances and  sales discount

• Net sales are the first item on the income statement

• Sales returns and allowances have debit balance

• Sales discounts have credit balance

▪ Income before income tax/pretax income = Income from operation – other income and expense

▪ Net income = Income before income tax – income tax

• A company’s profitability is determined by observing net income • Operating income should be observed in addition to net income  because it may be better determinant of profitability since it is  

profit that can be replicated

o Two main sections of multi-step income statement:

Operating/ Selling General and Administrative (SG&A) expenses section ▪ Contains revenues and expenses related to the principal business  activities of the company

▪ Income from Operations = Revenue – Operating expenses

▪ Consists mostly of selling and administrative expenses

Nonoperating/other income and expense section

▪ Contains revenues and expenses that are incidental to the company’s  principal business activities (e.g. gains or losses on the sale of equipment)

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