Accounting for Lawyers Flashcards
Free Cash Flow
Describes net cash provided by operating activities after adjusting for capital expenditures & dividends paid.
Free Cash Flow = Net Cash (provided by operating activities) - Capital Expenditures - Cash Dividends
Useful Information (as defined by FASB & IASB)
Has 2 fundamental qualities: relevance and faithful representation.
Relevance = has predictive value
- materiality is a company-specific aspect of relevance. An item is material when its size makes it likely to influence the decision of an investor or creditor.
Faithful representation = complete, neutral, free from error.
Enhancing Qualities (FASB/IASB)
Comparability, verifiability, timeliness, and understandability. consistency
Monetary Unit Assumption
Requires that only things that can be expressed in money are included in the accounting records. Things like customer satisfaction not reported.
Economic Entity Assumption
Every economic entity can be separately identified/accounted for. Important not to blur company transactions with personal transactions or transactions of other companies.
Periodicity Assumption
Life of a business can be divided into artificial time periods & that useful reports covering those periods can be prepared for the business.
Going Concern Assumption
The business will remain in operation for the foreseeable future.
Historical Cost Principle
Companies record assets at their cost. True at time asset purchased & over the time asset is held.
Tradeoff is btwn relevance and faithful representation.
Fair Value Principle
Price received to sell an asset or settle a liability. May be more useful for certain types of asset/liabilities like investment securities.
Tradeoff is btwn relevance and faithful representation. In general, FASB indicates most assets must follow historical cost principle bc market values may not be representationally faithful. Only I situations where assets are actively traded is the fair value principle applied.
Full Disclosure Principle
Requires companies to disclose all circumstances & events that would make a difference to financial statement users.
If an important item cannot reasonably be reported directly in one of the four types of financial statements, then it should be discussed in notes that accompany the statement.
Cost Constraint
Accounting standard-setters must consider the cost companies incur to provide information against benefit that financial statement users gain from having it available.
Accounting Information System
System of collecting & processing transaction data & communicating financial info to decision-makers.
Factors include: type of transactions, nature of the business, size of company, volume of data, etc.
Accounting Cycle
- Analyze Business Transactions
- Journalize
- Post
- Trial Balance
- Adjusting Entries
- Adjusted Trial Balance
- Financial Statements
- Closing Entries
- Post-Closing Trial Balance
Accounting Transactions
Economic events that require recording in the financial statements
Basic Accounting Equation
Assets = Liabilities + Stockholders’ Equity
Account
An individual accounting record of increases/decreases in a specific asset, liability, stockholders’ equity, revenue, or expense item.
In simplest form, consists of Title, Debit, Credit = T-account. Use terms to describe where entries are made in accounts, do not mean increase/decrease.
Balance
If debit/credit exceed the other, a debit/credit balance exists.
Debit mean increase in cash. Credit means decrease in cash.
DC ADE LER Method for Debit/Credit
Debit +: Assets, Dividends, Expenses
Credit +: Liabilities, Equity, Revenue
Recording Process
- Analyze each transaction in terms of its effects on the accounts
- Enter the transaction info in a journal
- Transfer the journal information to the appropriate accounts in the ledger
The Journal
- Discloses in one place the complete effect of a transaction
- Provides a chronological record of a transaction
- Helps to prevent or locate errors bc the debit/credit amounts for each entry can be readily compared
The Ledger
Provides the balance in each of the accounts and keeps track of changes in these balances.
General Ledger
Contains all the asset, liability, stockholders’ equity, revenue, and expense accounts.
Posting
Procedure of transferring journal entry amounts to ledger accounts.
1. In the ledger, enter in appropriate columns of the debited amount(s) the date & debit amount shown in the journal.
- In the ledger, enter in the appropriate columns of the credited amount(s) the date and credit amount shown in the journal.
The Trial Balance
Proves the mathematical equality of debits & credits after posting. Sum of debit account balances = sum of credit account balances.
- List the account titles & their balances
- Total the debit column & total the credit column
- Verify the equality of the 2 columns
Does not prove that all transactions have been recorded or that the ledger is correct.
Operating Activities
Types of activities a company performs to generate profits.
Like receiving cash in advance from customer, receiving cash for services performed, paying cash for rent, paying cash for insurance policy, paying salaries.
Investing Activities
Purchase/sale of long lived assets used in operating the business OR purchase or sale of investment securities.
Like purchasing equipment.
Financing Activities
Borrowing money, issuing shares of stock, and paying dividends.
Like issuing stock, note payable, or paying cash dividend to stockholders.
Revenue Recognition Principle
Companies must recognize revenue in the accounting period in which the performance obligation is satisfied.
Expense Recognition Principle (Matching Principle)
Efforts (expenses) must be recognized with results (revenues) in the period wen the company makes efforts to generate those revenues.
Accrual-basis Accounting
Transactions that change a company’s financial statements are recorded in the periods in which the events occur.
Cash-basis Accounting
Companies record revenue at the time the receive cash.
Adjusting Entries
Ensure that revenue/expense recognition principles are followed. Necessary bc the trail balance may not contain up-to-date/complete data.
Required every time a company prepares financial statements. Every adjusting entry will include 1 income statement account & 1 balance sheet account.
Types of Adjusting Entries
Deferrals:
- Prepaid expenses: expenses paid in cash before they are used or consumed.
- Unearned revenues: cash received before the services are performed
Accruals
- Accrued revenues: revenues for services performed but not yet received in cash or recorded.
- Accrued expenses: expenses incurred but not yet paid in cash or recorded
Adjusting Entry: Prepaid Expenses
Results in an increase (a debit) to an expense account and a decrease (credit) to an asset account.
Adjusting Entry: Unearned revenues
Results in a decrease (debit) to a liability account and an increase (credit) to a revenue account.
Adjusting Entry: Accrued revenues
Results in an increase (a debit) to an asset account and an increase (a credit) to a revenue account.
Adjusting Entry: Accrued expenses
Results in an increase (a debit) to the expense account and an increase (a credit) to the liability account.
Made up of accrued interest & accrued salaries.
Temporary Accounts
Because revenues, expenses, dividends accounts relate only to a given accounting period.
- revenue accounts
- expense accounts
- dividends
Permanent Accounts
Balance sheet accounts bc balances carried forward into future accounting periods.
- asset accounts
- liability accounts
- stockholders’ equity accounts
Closing Entries
Process in which companies transfer the temporary account balances to the permanent stockholders’ equity account - retired earnings.
Closing entries transfer net income/loss and dividends to Retained Earnings, so the balance in Retained Earnings agrees w/the retained earnings statement.
Income Summary
Temporary account to chin revenue & expense accounts are closed.
Post-Closing Trial Balance
Purpose is to prove equality of the total debit balances & total credit balances of the permanent account balances that the company carries forward into the next accounting period.
Since all temp accounts will have zero balances, post-closing trial balance will contain only permanent - balance sheet - accounts.
Merchandising Company - aspects
Sales Revenue
Cost of goods
Operating expenses
Perpetual Inventory System
Companies keep detailed records of the cost of each inventory purchase & sale. Company determines cost of good sold each time a sale occurs.
Traditionally for companies that sell merchandise with high unit values.
Periodic Inventory System
Companies don’t keep detailed inventory records of goods on hand throughout the period and instead determine the COGS only at the end of the accounting period.
Purchase Allowance
Purchaser may choose to keep the merchandise if the seller is willing to grant an allowance (deduction) to the purchase price.
Purchase Discount
Cash discount to buyer for prompt payment.
Single-step Income Statement
One step: subtracting total expenses from total revenues, is required in determining net income/loss.
Used for 1) company does not realize any type of profit/income until total revenues exceed total expenses so it makes sense to divide statement into these 2 categories + 2) form is simple/easy to read
Multiple-step Income Statement
Highlights the components of net income. Has 3 important line items.
- Gross Profit = net sales - COGS
- Income from operations = gross profit - operating expenses
- Net Income = income from operations -/+ activities not related to operations
Gross Profit
merchandising profit of company but not measure of overall profit bc operating expenses have not been deducted
Nonoperating activities
various revenues & expenses & gains & losses unrelated to company’s main line of operations
- Other Revenues & Gains
- interest revenue
- dividend revenue
- rent revenue
- gain (from PPE) - Other Expenses & Losses
- interest expense
- casualty losses
- loss (from PPE)
- loss (from strikes by employers/employees)
Comprehensive Income Statement
Presents items not included in the determination of net income. Part of fair value principle requiring companies to mark recorded values of certain types of assets/liabilities to their fair values at the end of each reporting period.
Gross Profit Rate
Company’s gross profit expressed as a percentage.
Gross Profit/Net Sales = Gross Profit Rate.
Profit Margin
Measure the percentage of each dollar of sales that results in net income.
Net income/net sales (revenue)
Gross Profit Rate vs Profit Margin
Gross profit rate measures margin by which selling price exceeds cost of goods sold. Profit margin measures extent by which selling price covers ALL expenses.
Quality of Earnings Ratio
Quality of Earnings Ratio = Net Cash Provided by Operating Activities / Net Income
Measures < 1 might be red flag about aggressive accounting techniques accelerating income recognition.
Accounts Receivable
Amounts customers owe on account. Result from sale of goods & services. Generally expect to collect accounts receivable within 30-60 days. Usually most significant type of claim held by company.
