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financial acct exam 1 notes

by: kmb0095

financial acct exam 1 notes ACCT 2110

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all notes & clicker questions for exam 1 { 8/16 - 8/25 }
Financial Accounting
Jennifer Cornett
Class Notes
financial accounting




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This 17 page Class Notes was uploaded by kmb0095 on Monday August 29, 2016. The Class Notes belongs to ACCT 2110 at Auburn University taught by Jennifer Cornett in Fall 2016. Since its upload, it has received 197 views. For similar materials see Financial Accounting in Accounting at Auburn University.


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Date Created: 08/29/16
Week 1 8/16/16  What is accounting o The process of identifying, measuring, recording, and communicating economic information for effective decision making o “language of business” o communicates financial information about a business to interested users  internal users (finance directors, production and marketing)  use financial info to make decisions  external users (bankers (loan or nah), investors, creditors, analysts, regulatory bodies)  focus of the semester: why is financial reporting beneficial to external users? o Accounting answers questions  Demand for acct info and typical questions  Managers – “how effective was the last advertising campaign?” o Internal  Employees – “will I get a raise this year?” o Internal  Investors – “will the company earn enough income to provide a satisfactory return?” o External  Creditors – “should I lend money to this business?” o External  Governments – “how much in taxes does this company owe?” o External  Types of business organizations o Sole proprietorship  Business owned by one person – bearing all risks and rewards associated with ownership  Advantages:  Easy to set up o Teens do it – lawn mowing service, house sitting  Owner controlled  Formed and dissolved at will by the owner  Tax advantage – individual rate  Disadvantages:  Personal liability o Liable for all harm  house sitting, forgot to lock the door, robbery  Financing more difficult o Teen wants a loan for a lawn mower, limited to amount the bank will let him borrow ($0 because he’s a minor so his parents have to borrow the money)  Hard to transfer ownership o Partnership  Business owned by two or more people  Small businesses and many professional practices of physicians, lawyers, and accountants are often organized as partnership  Ex) think of apartments – although you split costs and whatnot, each person is liable for 100% of risks  Advantages:  Simple to set up  Shared control  Increased access to financial resources and shared skills  Tax advantages – pass through entity (taxed at individual rates) o Income is calculated individually per partner (personal tax rate off money that is their part of the partnership)  Disadvantages:  Personal liability for partners – joint and several liability o Ex) marriage o Ex) if one person in an apartment gets a pet and gets caught, no one in the apartment can park & everyone has to pay  Hard to transfer ownership – automatically dissolved when one partner leaves the partnership o Can’t just pay someone to take your spot, it’s a process o Usually dissolved if someone leaves then a new partnership is formed in it’s place o Corporation  Separate legal entity (person) owned by stockholders  Organized under the laws of a particular state  Ownership held in the form of stock  Apple builds a new phone & that phone explodes in people’s faces, immediate response in the market  Apple liable for the explosive phones  However, even if apple manufactures these explosive phones, the injured cannot attack the stockholders (stockholders ARE NOT liable)  Can be private or public, depends on who can buy the stock  Privately held o Ownership is not available to the general public  Publicly held o Ownership available to the public at large, usually traded on public exchange  Advantages:  Greater potential for raising capital  Lower legal liability  Easy to transfer ownership  Disadvantages:  Complex process to begin and maintain  Unfavorable tax treatment: double taxation = higher tax rates 8/18/16 o Limited liability companies (LLC)  Not in book  Business owned by one or more people  Hybrid partnership-corporation  Pass-true tax structure of partnerships and sole proprietorships – more favorable tax treatment  Limited liability for partner/member  3 kinds of business activities o financing activities – borrow/acquire funds to begin and operate a business  borrowing money “liabilities”  bank loan  debt securities  good on credit from suppliers (A/P)  issuing stock “equity”  ownership contributions (stock) o investing activities – asset/resource acquisition to enable a business to operate o operating activities  revenue from sales/services  expenses (or costs) associated with earning revenue  praying for more revenue than expenses (net income) You are in the process of organizing a new business as a drug manufacturer. Assume you have obtained all of the necessary licenses and approvals to manufacture prescription drugs legally. Your biggest concern is the area of personal liability you would have due to the risks associated with this kind of enterprise. This being the case, which type of entity would you probably choose? - Corporation – liability protection  accounting terms & account types o assets  resources that will provide a future benefit  ex) cash, car, building, accounts receivable (something you expect to receive cash for – like waiting for a customer/client to pay you for something), inventory, investments o liabilities  obligations requiring a future sacrifice of a resource  “obligation to do or pay something”  ex) accounts payable, notes payable, taxes payable o equity (stockholders’ equity)  “equity belongs to owners, if we’re a corporation then the ownership is in terms of stock”  difference between assets and liabilities – represents share of assets claimed by owners  contributed capital – resources exchanged for ownership interest  all amounts people pay for our stock in a company – represents ownership  retained earnings – profits earned and retained in the business  “amount of net income a business has retained over a lifetime, choose to keep in the business or share with the owners which is a dividend” o dividends – portion of profits distributed to the owners o revenues  increase of assets due to sale of goods/services  “comes about when you sell something (service or product), customer either gives you money then or later (lawn cutting, legal services, Walmart) so what Walmart charges you when you leave is revenue” o expenses  cost of assets used or liabilities created due to sale of goods/services  basic accounting equation o assets = liabilities + stockholders’ equity  assets  left side shows the assets, or economic resources of a company  liabilities  right side indicates who has a claim on the company’s assets  creditor claims are liabilities  stockholders’ equity  owner claims in the form of stockholders’ equity  4 basic financial statements o income statement  how much we had in revenues and expenses  success of operations over period of time o retained earnings statement  “after knowing net income, do we want to share or keep it all?”  net income/net loss  dividends paid and net income for period of time  changes in R/E balance  net income + dividends (money given back to stockholders) o balance sheet  snapshot at point in time  assets = liabilities + stockholders’ equity o statement of cash flows  “tells you exactly how the company uses cash”  uses of cash over a period of time  cash effects of operations, investing and financing activities  reconciles beginning cash with ending cash  timing of financial statements o January – balance sheet at beginning of period o December – balance sheet at end of period o Retained earnings statements, income statement, statement of cash flow all tell what happens between the balance sheets What items appear on a balance sheet? - Accounts receivable (asset), retained earnings (stockholders’ equity), inventory (stuff that you buy & sell for a higher price which gives benefit, so its an asset & resource), accounts payable (means we owe something, so it’s a liability), contributed capital (stockholders’ equity) What items belong on the income statement? - Income tax expense, interest expense, service revenue What accounts appear on the statement of retained earnings? - Dividends  Comparability of financial statements o In order to make it easier to use financial statements over time and across companies, a common set of rules and conventions have been developed to guide the preparation of financial statements o These rules and conventions, called generally accepted accounting principles (GAAP), were developed by several different organizations over a number of years o In the US, the Securities and Exchange Commission (SEC) has the power to set accounting rules for publicly traded companies o However, the SEC has delegated this authority to the Financial accounting standards board (FASB) o “FASB dictates how we record things basically” o while the FASB is the primary accounting standard setter in the US, the FASB has been working closely with the International accounting standards board (IASB) in its development of international financial reporting standards (IFRS) Which one of the following is NOT one of the four basic financial statements?  Balance sheet  Income statement  Statement of cash flows  Auditor’s report  Classified balance sheet o Reports the financial position of a company (it’s assets, liabilities, and stockholders’ equity) at a specific point in time o Accounts are organized (“classified”) in categories according to shared economic similarities o Basic classification of assets is between current and noncurrent items – typically one year is the dividing line  Current – going to be liquidated into cash within the next year or operating cycle (whichever’s shorter)  Current resources: these are our resources that we expect to turn into cash in the near term  Cash is already current but think about accounts receivable – sales we’ve made & said they can pay us later o Want our customers to pay us within a year typically  Inventory – businesses buy stuff then sell it to customers for more money o You don’t want to wait a year to sell something you just bought, game is to buy what you know you can turn around and sell quickly o Inventory is expected to be cash within a year  If the operating cycle is longer than one year, this may be the dividing line  The operating cycle of a company is the average time that it takes a company to purchase goods, resell the goods, and collect the cash from customers o What does the company have?  Assets:  Current assets o cash, accounts receivable, inventories  Long-term investments, property, plant, and equipment o ex) buildings, land, vehicles, equipment, computers  Intangible assets o patents, copyrights o How did the company get it?  Liabilities:  Current liabilities o accounts payable, salaries payable  Long-term liabilities o notes payable, bonds payable  Stockholders’ equity:  Contributed capital o common stock  Retained earnings  The income statement o Operating success over a period of time o Cannot survive long-term with sustained losses o Past performance suggest the company’s ability to earn future income o Two major elements:  Revenues  Increase in assets that result from the sale of products or services (sales revenue/interest revenue)   Single step vs. multiple step o Single-step income statement  Net income is calculated in one step (revenue – expenses) o Multiple step income statement  Provides classifications of revenues and expenses that financial statement users find useful, with 3 important subtotals  Gross margin (gross profit) = net sales – cost of goods sold  Income from operations = gross margin – operating expenses  Net income = income from operations – (nonoperating revenues – expenses) 8/23/16  Ch.2 – conceptual framework o GAAP  Qualitative characteristics (subject to cost constraint)  (Characteristics that give quality to financial reports)  Fundamental o Relevance  Helps users predict future events (predictive value) or provides feedback about prior expectations (confirmatory value) o Faithful representation  Complete, unbiased and free from error  Accounting info should be faithful representation of the real-world economic event its trying to portray  Enhancing o (add to usefulness of financial statement) o should be maxed to the extent possible o Comparability  We can compare what we did last year (to the past) or to someone else that’s in the same industry (to someone outside of the company) o Verifiability  We can check out the story  Outside parties that corroborate info  More useful when the info can be verified o Timeliness  We don’t want to make a decision based on old financial statements  We’re more interested in what’s happening/happened lately  Gives us info that’s more relevant and useful to us o Understandability  A person who has studied about these things can understand what’s going on with the company  Assumptions  Anytime you’re looking at a financial statement, you should be able to assume certain things about it  Economic entity o In a financial statement, our assumption would be that only things related to that entity would be there o Ex) google  Googles only putting the info related to google in their statement  Continuity (going concern) o This business can keep going o we’d look at and put more caution to statements of companies where their continuity is questionable  Time period o Beneficial to break up info in specific time periods so we can better understand what’s going on o Why we might prepare an income statement for January, only want the statement to contain info in that month o Ex) monthly, quarterly, annually  Monetary unit o Use the same unit of money in all the statements o Ex) US dollars only, Japanese yen only Matt is entering into a partnership to start a bike shop with a friend. Each partner makes an initial investment of $8k. Matt opens a checking account in the partnership’s name and transfers $8 from his personal account. What accounting assumption is illustrated here? - Economic entity – act of taking personal money and putting it in the partnership’s name instead of keeping it in his account and saying its for the company  Principles  Orders we use to determine how to make transactions  GAAP is a rules based set of principles  Historical cost o Cost of what you pay for something is the best approximation of the value of something at that point in time  Revenue recognition o GAAP doesn’t connect recognition of revenue to cash only o Something is a revenue whenever its earned  Delivered a good  Performed a service o Just because cash comes in, doesn’t mean we’re talking about revenue o Ex) money for stock – not revenue, they bought ownership into the company/  Expense recognition (matching) o How we’re going to handle expenses o Expenses are matched up in the same period with the revenues they helped produce o Income statement tells us what we brought in in revenue and what expenses it took to take the revenue (net income or did we lose some) o Tells us if we successful in that period of time o Ex) paid for rent/power – gained benefit for the month, that’s an expense  Conservation o We want to be conservative o We don’t want to be recording things based on “it could be this” but rather conservative in what we do o We don’t want to do anything that could overstate the good things (assets [resources] and revenues) about us o Measuring business activities: the accounting cycle  Analyze transactions  Consider the event or transaction  What will the impact be on the balance sheet equation?  Can I put a number on this? What are the underlying accounts that would impact this equation?  Assets = liabilities + stockholders’ equity o ALWAYS remains true, cannot be false o Ex) Assets go up, something on the transaction must also go up Assets = liabilities + stockholders’ equity Stockholders’ equity = contributed capital + retained earnings Retained earnings = beginning retained earnings + revenues – expenses – dividends  Ex) Transaction 1: issuing common stock  Ex) Transaction 2: borrowing cash  Ex) Transaction 3: purchase of equipment for cash o Exchanging cash for something we’re getting a benefit from in the future o One asset goes up but another goes down as well so all change on the right side but none on the left, still in balance  Ex) Transaction 4: purchasing insurance o 6-month insurance policy for $12k o not an expense to us, its pre-paid insurance o its an asset because we haven’t used it yet but over time we do, so it’s a benefit to us o exchanging one asset for another, all change on the right side, still balanced  ex) Transaction 5: purchase of supplies on credit o purchased office supplies for $6,500 o company said we can pay them later for the supplies o account payable – obligation we have to pay later o supplies are a resource; we aren’t using them all but we’re using them over time (assets) o assets go up, obligation goes up (liabilities), so still in balance  ex) Transaction 6: sale of services for cash o sold advertising services for $8800 cash o assets go up, stockholders’ equity goes up (retained earnings)  whenever you have revenue, always having something positive happening to retained earnings  ex) Transaction 7: Sale of services for credit o sold advertising services but for account receivable (pay later)  always the result of revenue being earned but not being collected in cash o assets go up, retained earnings go up, balanced  ex) Transaction 8: receipt of cash in advance o received $9k for advertising services to be completed in the next 3 months  obligation (liabilities) with an unearned revenue  you have something that you have yet to deliver on, in this case it’s a service, so when this service is completed then it becomes revenue o assets ride, liabilities rise  ex) Transaction 9: payment of a liability o pays $6k cash for supplies previously purchased in transaction 5 o obligation is paid for o assets go down, liabilities go down  ex) Transaction 10: collection of a receivable o collected $3k cash from services sold in transaction 7 o assets are being exchanged, rid of receivable and getting cash back o revenue cycle is completed  called it a revenue when we billed the client, now the receivable is turned into cash  ex) Transaction 11: payment of salaries o paid weekly employee salaries of $1,800 o assets go down, retained earnings go down o as we have expenses that drives down net income our retained earnings decline o never going to be debiting or crediting retained earnings directly  recording revenues, expenses and dividends which impact retained earnings  anytime we record transactions during the month, they are in those 3 accounts knowing it impacts retained earnings as a result  ex) Transaction 12: payment of utilities  ex) Transaction 13: payment of a dividend o declared and paid cash dividend of $500 to stockholders o assets go down, retained earnings go down  Journalize transactions  double-entry accounting o describes the system used by companies to record the effects of transactions on the accounting equation o assets = liabilities + stockholders’ equity  stockholders’ equity  retained earnings o internally generated o company generated these just by doing what it does o does things well, retained earnings reps net income for the company o up with revenue (increase with credit), down with expense (decrease with credit), down with dividend (decrease with credit)  paid in capital o amounts we as a company received in exchange for ownership o externally generated o debits and credits  debits = left  normal debit balance  increased with debit, decreased with credits  if you want to make cash go down, credit it  if you want to make cash go up, debit it  ex) assets (cash, property, plant equipment, pre-paid insurance or rent, investments, intangibles, etc.)  only things that increase assets abide by these rules, contra-assets have a whole other set  credit = right  normal credit balance  increased with credit, decreased with debit  credits up, debits down  ex) liabilities & stockholders’ equity  same  Post in the ledger  Prepare the trial balance  Adjust the accounts  Prepare financial statements  Close the accounts o Capturing account info: key terms  Accounting transaction  Any economic event that affects a company’s assets, liabilities or equity at the time of the event  Someone gets hired and starts sept1, transaction wouldn’t occur until their first day of work  Account  An accounting record that accumulates the activity of a specific item and yields the item’s balance  Keeps up with individual broken down elements that belong under assets, stockholders’ equity, liabilities, revenue, expense  Ex) rent, utility, insurance, etc.  Always doing something to a specific account that has a specific use  Keeps track of changes in accounts  Chart of accounts  List of accounts that a company uses to capture its business  (Just a list of all accounts we’re going to use)  wages expense, salaries expense, employees expense o all the same o events and transactions  events must be recorded in financial statements  external events  between company & outside party  transactions o involving exchange of assets, liabilities or stockholders’ equity o must be recorded  internal events  economic events that occur within the company  transactions o ONLY IF it results in a financial impact that you can measure with reasonable accuracy 8/25/16 Which of the following groups of accounts shows only those accounts that are increased with a debit?  Assets, liabilities, dividends  Assets, equity, dividends  Assets, expenses, dividends  Assets, equity, expenses Cash Acct Acct Notes supplies receivable payable payable Debit Cred Debit Credi Debit Credi Debit Credi Debit Credi it t t t t 8,000 15,90 2,500 4,100 4,100 + 0 15,000 = 23,000 Common stock Retained earning Debit Credit Debit Credit 12,000 9,500 + 15,000 = 27,000 Assets = liabilities + stockholders’ equity Aug: increase cash $15,000 n/e increase common stock $15,000 Decrease cash $850 (rent expense) n/e retained earnings down $850 (rent expense) Supplies increase $2,250 Acct payable $2,250 n/e Cash increases $8,000 increase note payable $8,000 n/e Cash decreases $1,080 decrease acct payable $1,080 n/e Decrease cash $2,150 n/e retained earnings decrease $2,150 Increase cash $4,100 n/e retained earnings up $4,100 (service revenue) Decrease supplies $3,180 n/e retained earnings down $3,180 (supplies expense) Acct receivable up $1,920 n/e retained earnings increase (service revenue) Cash decrease, supplies up $500 n/e n/e Cash increase, acct receivable down $1,290 n/e n/e Cash decrease $1,000 n/e retained earnings down (dividend increase) Dat Accounts Debit Credit e Aug Cash 15,000 Common stock 15,000 Aug Rent expense 850 Cash 850 Aug Supplies 2,250 Acct payable 2,250 Aug Cash 8,000 Note payable 8,000 Aug Acct payable 1,080 Cash 1,080 Aug Salaries expense 2,150 Cash 2,150 Aug Cash 4,100 Service revenue 4,100 Aug Supplies expense 3,180 Supplies 3,180 Aug Acct receivable 1,920 Service revenue 1,920 Aug Supplies 500 Cash 500 Aug Cash 1,290 Acct receivable 1,290 Aug Dividends 1,000 Cash 1,000  Prepare a trial balance o To aid in the preparation of financial statements o Trial balance – list of all active accounts and each account’s debit or credit balance o Accounts are listed in the order they appear in ledger (assets, liabilities, stockholders’ equity, revenues, expenses) EXAM REVIEW  60% Multiple choice (ch.1-2GREEN SCANTRON o Conceptual questions (memorization, basic terminology) o A lot of problem solving o 20 questions, 3 pts each  Open format o List of accounts, ask to identify which accounts are what type o Transaction scenarios and evaluate impact on assets, liabilities & stockholders’ equity o Journal entries  Which account should be debited/credited


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