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AuditSight Domain Knowledge > Accounting Made Simple > Flashcards

Accounting Made Simple Flashcards

1
Q

What is the fundamental equation of accounting?

A

Assets = Liability + Owners’ Equity

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2
Q

What are assets?

A

All of the property owned by the company

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3
Q

What are liabilities?

A

All of the debts that the company currently has outstanding to lenders

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4
Q

What is the owners’ equity?

A

The company ownership interest in its assets, after all debts have been repaid. Essentially, Assets - Liabilities.

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5
Q

What are “cash and cash equivalents” assets?

A

Balances in checking and savings accounts, as well as any investments that will mature within three months or less.

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6
Q

What are “inventory” assets?

A

Goods kept in stock, available for sale

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7
Q

What are “accounts receivable” assets?

A

Amounts due from customers for goods or services that have already been delivered.

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8
Q

What are “property, plant, and equipment” assets?

A

Assets that cannot be readily converted into cash – things such as computers, manufacturing equipment, vehicles, furniture, etc.

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9
Q

What are “accounts payable” liabilities?

A

Amounts due to suppliers for goods or services that have already been received.

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10
Q

What are “notes payable” liabilities?

A

Contractual obligations due to lenders, like bank loans

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11
Q

What is “common stock” owners’ equity?

A

Amounts invested by the owners of the company

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12
Q

What is “retained earnings” owners’ equity?

A

The sum of all net income over the life of the business that has not been distributed to owners in the form of a dividend.

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13
Q

What are current vs long-term assets and liabilities?

A

Current will be converted into cash in twelve months or less.

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14
Q

What is an income (AKA Profit and loss, P&L) statement?

A

A document that shows the company’s financial performance over a period of time (usually a year)

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15
Q

How is an income statement different from a balance sheet?

A

The income statement shows a period of time, whereas a balance sheet shows a point in time. Balance sheet is like a photograph, income statement is like a video.

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16
Q

What is Gross Profit?

A

Revenues minus Cost of Goods Sold

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17
Q

What is Cost of Goods Sold?

A

The amount that the company paid for the goods that it sold over the course of the period.

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18
Q

What are non-operating revenues and expenses?

A

Those that are unrelated to the core operations of the business, such as interest income, interest expense, and gains/losses on investments.

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19
Q

What is a statement of retained earnings?

A

A document that details the changes in a company’s retained earnings over time.

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20
Q

How does the statement of retained earnings bridge the income statement and balance sheet?

A

It takes information (net income) from the income statement, and provides information (retained earnings) to the balance sheet.

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21
Q

Are dividends an expense on the income statement?

A

No, they are a distribution of profits, appearing on the statement of retained earnings.

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22
Q

Are retained earnings the same as cash?

A

No, a company could reinvest the earnings in itself.

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23
Q

What is the cash flow statement?

A

It reports a company’s cash inflows and outflows over an accounting period.

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24
Q

What are the differences between a cash flow statement and an income statement?

A

A cash flow statement records when cash actually comes or goes, as opposed to debts being created. The cash flow statement also includes some types of transactions that don’t show up on the income statement.

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25
Q

What are the three categories of cash flow?

A

Cash flow from operating activities
Cash flow from investing activities
Cash flow from financing activities

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26
Q

What is cash flow from operating activities?

A

Any cash flows not specifically defined as investing or financing activities

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27
Q

What type of cash flow is receipts from the sale of goods or services?

A

Cash flow from operating activities

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28
Q

What type of cash flow is “payments made to suppliers”?

A

Cash flow from operating activities

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29
Q

What type of cash flow is “payments made to employees”?

A

Cash flow from operating activities

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30
Q

What type of cash flow is “interest payments made to lenders”?

A

Cash flow from operating activities

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31
Q

What type of cash flow is “interest or dividends received from investments”?

A

Cash flow from operating activities

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32
Q

What type of cash flow is “tax payments”?

A

Cash flow from operating activities

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33
Q

What is cash flow from investing activities?

A

Cash spent on, or received from the sale of, investments in financial securities or capital assets (i.e. ones expected to last longer than a year)

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34
Q

What type of cash flow is “purchase or sale of property, plant, or equipment”?

A

Cash flow from investing activities

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35
Q

What type of cash flow is “purchase or sale of stocks or bonds”?

A

Cash flow from investing activities

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36
Q

What is cash flow from financing activities?

A

Cash inflows/outflows relating to transactions with the company’s owners and creditors

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37
Q

What type of cash flow is “cash received from investors when new shares of stock are issued”?

A

Cash flow from financing activities

38
Q

What type of cash flow is “dividends paid to shareholders”?

A

Cash flow from financing activities

39
Q

What type of cash flow is “Cash received from taking out a loan”?

A

Cash flow from financing activities

40
Q

What type of cash flow is “cash paid to pay back the principal on a loan”?

A

Cash flow from financing activities

41
Q

What type of cash flow is “cash paid to pay back the interest on a loan”?

A

Cash flow from operating activities

42
Q

In liquidity ratios, what is the “current ratio”?

A

An assessment of the company’s ability to pay off its current ( < 1 year) liabilities with its current assets.

Current Ratio = Current Assets / Current Liabilities

43
Q

What is the Quick Ratio?

A

Assesses the company’s ability to pay off its current liabilities, without selling inventory

Quick Ratio = (Current Assets - Inventory) / Current Liabilities

44
Q

What is the Return on Assets ratio?

A

How efficiently is this company using its assets to generate profits?

Return on Assets = Net Income / Total Assets

45
Q

What is the Return on Equity ratio?

A

How efficiently is this company using its investors money to generate profits?

Return on Equity = Net Income / Shareholders’ Equity

46
Q

What is Gross Profit Margin?

A

The percentage of sales remaining after covering the cost of the sold inventory.

Gross Profit Margin = (Sales - Cost of Goods Sold) / Sales

47
Q

When is it useful to compare companies’ Gross Profit Margins?

A

When they are in the same industry. You should expect different Gross Profit Margins to be “normal” in different industries, e.g. grocery store probably won’t have the same as a software company.

48
Q

What are Financial Leverage Ratios?

A

Ratios that show the extent to which a company has used debt (instead of investor capital) to finance its operations.

49
Q

What is a company’s debt ratio?

A

Debt Ratio = Liabilities / Assets

50
Q

What is the Debt to Equity Ratio?

A

Debt to Equity Ratio = Liabilities / Owners’ Equity

51
Q

What are the pros/cons of a company using leverage?

A

Con: Risky
Pro: Increased leverage increases return on equity for a given amount of net income

52
Q

What are Asset Turnover ratios for?

A

Showing how efficiently a company uses its assets

53
Q

What is Inventory Turnover ratio?

A

Shows how many times a company’s inventory is sold and replaced over the course of a period

Inventory Turnover = Cost of Goods Sold / Average Inventory

Average Inventory = (Beg. Inventory Value + Ending Inventory Value) / 2

54
Q

What is the Inventory Period ratio?

A

Shows how long, on average, inventory is on hand before it is sold

Inventory Period = 365 / Inventory Turnover

55
Q

What do a high Inventory Turnover / low Inventory Period show?

A

That inventory is selling quickly, and that in-demand products are being stocked

56
Q

What is Receivables Turnover?

A

How quickly the company is collecting upon its accounts receivable

Receivables Turnover = Credit Sales / Avg. Accounts Receivable

57
Q

What is Average Collection Period?

A

Average length of time that a receivable from a customer is outstanding prior to collection

Average Collection Period = 365 / Receivables Turnover

58
Q

What is GAAP?

A

Generally Accepted Accounting Principles, the framework of accounting rules used in the preparation of financial statements. Created by the Financial Accounting Standards Board (FASB), in order for potential investors to be able to compare financial statements of different companies to determine which ones they want to invest in.

59
Q

Who is required to follow GAAP?

A

All publicly traded companies, and governmental entities (though they have different rules)

Many companies follow them even when not required, because of their prevalence in the field of accounting.

60
Q

What are Debits and Credits?

A

In double entry accounting, each transaction must have two halves. A debit entry will increase an asset account, and will decrease a liability or owners’ equity account. A credit entry will decrease an asset account, and increase a liability or owners’ equity account.

61
Q

What type of entry do we typically use for revenue accounts?

A

Credit

62
Q

What type of entry do we typically use for expense accounts?

A

Debit

63
Q

What is the General Ledger?

A

The place where all of a company’s journal entries get recorded. Its information is used to create financial statements.

64
Q

What is a T-Account?

A

A display of the credits and debits to a single account, for a given time period, in a T-shaped chart, with debits on the left and credits on the right.

65
Q

What is a Trial Balance?

A

A list indicating the balances of every single GL account at a given point in time.

66
Q

What’s the purpose of a Trial Balance?

A

To check that total debits equal total credits.

67
Q

Can a Trial Balance catch all types of errors in a GL?

A

No, it wouldn’t catch if the wrong asset account had been debited for a given transaction, since the total debits would still be correct.

68
Q

Under the accrual method of accounting, when is revenue/expenses recorded?

A

As soon as services are provided or goods are delivered/received, regardless of when cash is received/paid.

69
Q

Why does GAAP use accrual instead of the cash method of accounting?

A

To avoid the distortion of economic reality due to the time lag between a service being performed and the service being paid for.

70
Q

What are prepaid expenses / unearned revenue?

A

When cash is exchanged before the good/service is delivered.

71
Q

What are Closing Journal Entries for?

A

Zeroing out temporary accounts at the end of an accounting period, and moving their balances to an income summary account.

72
Q

After the (temporary) income statement accounts have been zeroed out by closing journal entries, the income summary account has a balance that represents ___.

A

The firm’s net income/loss for the period.

73
Q

After the (temporary) income statement accounts have been zeroed out by closing journal entries, the income summary account has a balance that represents the firm’s net income for the period. A journal entry is then made to transfer this balance to ___.

A

The Retained Earnings account.

74
Q

Why is an income summary account used instead of closing out the income statement accounts directly to the Retained Earnings account?

A

To keep the Retained Earnings account from getting cluttered with numerous journal entries at the end of each accounting period

75
Q

What is the Historical Cost GAAP assumption?

A

That assets are generally recorded at the amount paid for them at the time.

76
Q

What is the Materiality concept of GAAP?

A

The impact that a transaction will have on the company’s financial statements, i.e. if an omission of a given transaction could cause a viewer of the financial statements to make different decisions.

77
Q

What is the Monetary Unit Assumption of GAAP?

A

The assumption that the dollar is a stable measure of value

78
Q

What is the Entity Assumption of GAAP?

A

That a company is an entirely separate entity from its owners.

79
Q

What’s the Matching Principle of GAAP?

A

That expenses must be matched to the revenues that they helped generate, and must be recorded in the same period in which the revenues are recorded.

80
Q

What is the process of spreading out the cost of an asset over several years?

A

Depreciation

81
Q

What is straight line depreciation?

A

When the cost of the asset is spread out evenly over the expected life of the asset?

82
Q

What is Salvage Value?

A

The value that the asset is expected to have after the planned number of years of use.

83
Q

If a fully depreciated asset is sold for more or less than its expected salvage value, how is that factored in?

A

Gains/loss on sale.

Gains work like revenue, having a credit balance and increasing owners’ equity.

Losses work like expenses, having a debit balance and decreasing owners’ equity.

84
Q

What are some other GAAP-approved depreciation methods?

A

Double declining - value decreases by a percentage

Units of Production - Depreciation is a function of how much the asset is used

85
Q

Are immaterial assets depreciated?

A

No, the increased accuracy of accounting isn’t worth the time spent

86
Q

What are intangible assets?

A

Real, identifiable assets that are not physical objects, like intellectual property

87
Q

What is amortization of an intangible asset?

A

Analogous to depreciation, amortization is when an intangible asset’s cost is spread out over its life.

88
Q

What is the period for straight-line amortizing an intangible asset?

A

The shorter of:

The asset’s expected useful life, or
The asset’s legal life

89
Q

What are the two primary GAAP methods of tracking inventory?

A

Perpetual method, and periodic method

90
Q

What is the Perpetual Method of Inventory?

A

Keeping real-time information on inventory levels, and tracking inventory on an item-by-item basis

91
Q

What is the Periodic Method of Inventory?

A

When inventory is counted at regular intervals

AuditSight Domain Knowledge (1 decks)

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