Chapter 1: Accounting and the Financial Statements Flashcards
a company’s annual report
Form 10-K
a set of standardized reports in which the detailed transactions of a company’s activities are reported and summarized so they can be communicated to decision-makers
financial statements
the process of identifying, measuring, recording, and communicating financial information about a company’s activities so decision-makers can make informed decisions
accounting
Accounting is the language of _________
business
Demand for accounting information coming from OUTSIDE the business is what TYPE of accounting?
financial accounting
Who are the “users” of accounting information in FINANCIAL accounting?
- Investors (owners)
- Creditors (lenders)
Demand for accounting information coming from INSIDE the business is what TYPE of accounting?
managerial accounting
Who are the “users” of accounting information in MANAGERIAL accounting?
managers
What do investors (owners) use accounting information for?
To evaluate the future prospects of a company and decide where to invest their money.
What do creditors (lenders) use accounting information for?
To evaluate whether to loan money to a company.
Who are three other external users of accounting information?
- Governmental Agencies
- Labor Unions
- Financial Analysts
What are the four basic financial statements?
- The Balance Sheet
- The Income Statement
- The Retained Earnings Statement
- The Statement of Cash Flows
a business that has an identity separate from that of its owners and managers and for which accounting records are kept
accounting entity
What are the THREE forms of business organization?
- Sole Proprietorship
- Partnership
- Corporation
Sole proprietorships account for ____% of all businesses.
70%
What type of business organization does the following describe?
- Usually small, local businesses
- easily formed, tax advantages, and owner has control over the business
- The owner is personably responsible for the debt of its business
- Can be formed or dissolved at the wishes of the owner, limited life
Sole Proprietorship
What type of business organization does the following describe?
- small businesses and mainly professional practices (lawyers, physicians, accountants)
- provide increased access to financial resources and the individual skills of each person
- _______ entity doesn’t pay taxes; each person pays taxes at his or her individual rate
- both people are jointly responsible for all the debt of the business
partnership
a company chartered by the state to conduct business as an “artificial person” and owned by one or more stockholders (ex: Apple)
corporation
T or F: The stockholder’s legal responsibility for the debt of a corporation is limited to the amount they invested in the business.
True
Shares of stock can be easily transferred from one owner to another through ______ markets without affecting the corporation that originally issued the stock.
capital
What are 3 advantages of a CORPORATION business organization?
- Ability to raise capital by selling new shares of stock
- The limited liability of owners (stockholders)
- The transferability of shares
What are 2 disadvantages of a CORPORATION business organization?
- Requirements to form are more complex
- Owners generally pay more taxes
What are the 2 reasons that owners of a corporation generally pay more taxes?
- The corporate income tax is greater than the individual income tax rate.
- A corporation’s income is taxed twice (at the corporate level and at the individual level) (called double taxation)
Majority of business in the U.S. is conducted by __________.
corporations
What are the three business activities?
- Financing Activities
- Investing Activities
- Operating Activities
Which business activity does this describe?
- obtaining funds to start a business (from owners or creditors)
financing activities
Which business activity does this describe?
- buying resources (assets) used to generate revenues
investing activities
Which business activity does this describe?
- operating the business to earn a profit
operating activities
T or F: When borrowing money (getting a loan) from another entity such as a bank, the business MUST repay the amount borrowed.
True
the person to whom money is owed (ex: bank)
creditor
obligation to repay a creditor; can take many forms
liability
a corporation borrowing money with the promise to repay the amount borrowed PLUS INTEREST at a future date
notes payable
special form of note payable used by corporations to obtain large amounts of money
bond payable
the dollar amount paid to a corporation for the shares of stock and represents the basic ownership interest in a corporation
common stock
T or F: corporations DO NOT have to repay stockholders the amount invested
True
distributions of a portion of a corporations earnings to stockholders on a regular basis
dividends
economic resources representing expected future economic benefits controlled by the business (ex: cash, accounts receivable, inventory, land, buildings, equipment, and intangible assets)
assets
T or F: In the case of financial difficulty or distress, the claims of the creditors (liabilities) must be paid prior to the claims of the stockholders (stockholders’ equity)
True
the owner’s (investors) claims against the assets of a corporation after all liabilities have been deducted; claims of the stockholders.
stockholder’s equity
the purchase and sale of assets used in operations (commonly referred to as property, plant, and equipment) are a corporation’s _____ activities.
investing
the increase in assets that results from the sale of products or services
revenue
the cost of assets used up in the creation of liabilities during the operation of a business
expenses
amounts owed to employees for work performed
wages payable
If revenues > expenses =
net income
If expenses > revenues =
net loss
a financial statement that reports the resources (assets) owned by a company and the claims against those resources (liabilities and stockholder’s equity) at a specific point in time
The Balance Sheet
a financial statement that reports the profitability (revenues, expenses, and income) of a business over a specific period of time; reporting how well a company’s operations has performed over a period of time
The Income Statement
a financial statement that reports how much of the company’s income was retained in the business and how much was distributed to owners for a period of time
The Retained Earnings Statement
a financial statement that provides relevant information about a company’s cash receipts (inflows of cash) and cash payments (outflows of cash) during an accounting period; expressing the sources and uses of a company’s cash over a period of time
Statement of Cash Flows
Most companies prepare financial statements at the end of each ____, ______, and ________.
month, quarter, and year
the rules and conventions used to prepare financial statements that help decision-makers to compare performance over time and across companies
Generally Accepted Accounting Principles (GAAP)
the federal agency established by Congress to regulate securities markets and ensure effective public disclosure of accounting information.
Securities and Exchange Commission (SEC)
The Securities and Exchange Commission (SEC) has the power to set accounting rules for _______ ______ companies.
publicly traded
the primary accounting standard-setter in the US which has been granted the power to set standards by the SEC.
Financial Accounting Standards Board (FASB)
an independent, privately funded accounting standard-setting body with the goal of developing a single-set of high-quality accounting standards that result in transparent and comparable information reported in general purpose financial statements
International Accounting Standards Board (IASB)
a general term that describes an international set of generally accepted accounting standards
International Financial Reporting Standards (IFRs)
What is the fundamental accounting equation?
Assets = Liabilities + Stockholder’s Equity
T or F: In the fundamental accounting equation, assets must ALWAYS BE EQUAL TO liabilities + stockholder’s equity
True
an accounting period that runs for one year
fiscal year
cash and other assets that are reasonably expected to be converted into cash within one year or one operating cycle, whichever is longer; listed in order of liquidity
current assets
the average time that it takes for a company to purchase goods, resell them, and collect the cash from customers
operating cycle
Companies typically designate ___ year(s) as the dividing line between current and noncurrent assets
one
What are 5 common types of CURRENT assets?
- Cash
- Marketable Securities
- Accounts Receivable
- Inventories
- Prepaid expenses (advance payment for rent, insurance, and other services)
short-term investments in the debt and stock of other companies as well as government securities
marketable securities
the right to collect an amount due from customers
accounts receivable
What are 3 common types of NONCURRENT assets?
- Long-term investments
- Property, plant, and equipment
- Intangible Assets
investments that the company expects to hold on to for longer than one year (this includes land or buildings that a company is not currently using in operations, as well as debt and equity securities)
long-term investments
the tangible, long-lived, productive assets used by a company in its operations to produce revenue (includes land, buildings, machinery, manufacturing equipment, office equipment, and furniture)
property, plant, and equipment
companies allocating a portion of an (property, plant, or equipment) asset’s cost as an expense in each period in which the asset is used
depreciation
the total amount of depreciation that the company has expenses over the life of its assets
accumulated depreciation
the difference between the cost and the accumulated depreciation is the asset’s:
book value (or carrying value)
What are 4 examples of intangible assets?
- Copyrights
- Patents
- Trademarks
- Goodwill
obligations that will be satisfied, through the payment of cash or provision of goods or services, within one year or the operating cycle, whichever is longer.
current liabilities
What are 5 types of current liabilities?
- Accounts Payable
- Salaries Payable
- Unearned Revenue
- Interest Payable
- Income Taxes Payable
an obligation to repay a vendor or supplier for merchandise supplied to the company
accounts payable
an obligation to pay an employee for services performed
salaries payable
an obligation to deliver goods or perform a service for which a company has already been paid
unearned revenue
an obligation to pay interest on money that a company has borrowed
interest payable
an obligation to pay taxes on a company’s income (taxes owed to the government)
income taxes payable
the obligations of the company that will require payment beyond one year or the operating cycle, whichever is longer
long-term liabilities
What are two examples of long-term liabilities
- Notes payable
- Bonds payable
Stockholder’s Equity arises primarily from what two sources?
- Contributed Capital
- Retained Earnings
composed of the owner’s (investors) contributions of cash and other assets to the company and includes common stock
contributed capital
the accumulated net income of a company that has not been distributed to owners in the form of dividends
retained earnings
Together, a company’s liabilities and equity make up the ______ of a business.
capital
a company’s ability to pay obligations as they become due
liquidity
What are two useful measures of liquidity?
- Working Capital
- Current Ratio
Working Capital is a measure of liquidity computed as:
Current Assets - Current Liabilities
Why is the Income Statement useful to investors?
It provides them with information about a company’s ability to earn future income
the income statement consists of two major items:
- revenues and gains
- expenses and losses
what type of revenue arises from the principal activity of the business?
sales revenue
increase in net assets that occur from peripheral or incidental transactions (revenues from sources other than the sale of products or services)
gains
decreases in net assets that occur from peripheral or incidental transactions (expenses that are not associated with revenues)
losses
What is the equation for Net Income?
Net Income = Total Revenues - Total Expenses
What are the three important subtotals of a multi-step income statement?
- Gross Margin
- Income from Operations
- Net Income
measures the initial profit made from selling a product, but not total profit because other operating expenses have not yet been subtracted
gross margin
What is the equation for Gross Margin?
Gross Margin= Net Sales - Cost of Goods Sold
What is the equation for Income from Operations?
Income from Operations = Gross Margin - Operating Expenses
the expenses the business incurs in selling goods or providing services and managing the company
operating expenses
revenues and expenses from activities other than the company’s principal operations
nonoperating activities
For many companies, the most important non-operating item is ______ and ________ income.
Interest and investment income
What is the equation for income before taxes?
Income Before Taxes= Income from Operations - Nonoperating Items
What is the equation for Net Income in a multi-step income statement?
Net Income= Income Before Taxes - Income Taxes Expense
a useful measure of a company’s ability to generate profit (sometimes called return on sales)
Net Profit Margin
What is the equation for Net Profit Margin?
Net Profit Margin= Net Income / Sales (or Service) Revenue
the income earned by the company but not paid out in the form of dividends
retained earnings
What are the three steps of a retained earnings statement?
- List the retained earnings balance at the beginning of the period obtained from the balance sheet.
- Add net income from the income statement.
- Subtract any dividends declared during the period (should equal retained earnings at the end of the period as reported on the balance sheet)
Cash flows are divided into three categories:
- Cash flows from operating activities
- Cash flows from investing activities
- Cash flows from financing activities
any cash flows directly related to earning income. this includes cash sales and collections of accounts receivable as well as cash payments for goods, services, salaries and interest
cash flows from operating activities
any cash flow related to acquisition or sale of investments and long-term assets such as property, plant, and equipment
cash flows from investing activities
any cash flow related to obtaining capital of the company. this includes the issuance and repayment of debt, common stock transactions, and the payment of dividends
cash flows from financing activities
What do creditors use the statement of cash flows for?
To assess the creditworthiness of a company
individuals or entities that the corporation owes money to are called
creditors
obligations to repay creditors
liabilities
the long-term survival of a company depends on its ability to produce
net income
A company with healthy cash flow—particularly if it comes from operating activities—is in a
good position to repay debts as they come due, pay dividends, and is a ________ borrower.
low-risk
