Chapter 1: The Financial Statements Flashcards
Financial Statements
Are the business documents that companies use to report the results of their activities to various user groups
Accounting
Is an information system that measures business activities, processes data into reports, and communicates results to decision makers
Why is accounting called the “language of business”?
Because it produces financial statements, which report information about a business entity. The financial statements measure performance and communicate where a business stands in financial terms
Why do individuals use accounting information?
Accounting provides the necessary information to allow individuals to make decisions regarding personal bank accounts, renting a house, and budgeting monthly income
Why do investors and creditors use accounting information?
Investors want to know how much income they can expect to earn on an investment and creditors want to know when a corporation is going to pay them back
Why do regulatory bodies use accounting information?
The IRS and various state and local governments require businesses to pay taxes. The SEC requires companies whose stock is traded publicly to provide periodic financial reports
Why do non-profit organizations use accounting information?
Churches, hospitals, and charities base many of their operating decisions on accounting data
Financial Accounting
Provides information for decision makers outside the organization such as investors, creditors, government agencies, and the public. Information must be relevant for decision makers and represented faithfully depicting the entity’s current economic activities.
Managerial Accounting
Provides information for managers. Includes budgets, forecasts, and projections that are used in making strategic decisions of the entity
Proprietorship
Has a single owner and tend to be small retail stores or solo providers of professional services.
Liability of a Proprietorship
The proprietor is personally liable for all of the business’s debts.
Should the business finances and personal finances be mixed?
No
Partnership
Has 2 or more parties called co-owners and each owner is a partner. Income and loss flow through to the partners and they recognize it based on their agreed upon percentage interest in the business
How do partnerships pay taxes?
Each partner takes a proportionate share of the entity’s taxable income and pays according to that partner’s individual or corporate rate
How are partnerships governed?
Partnerships are governed by a contract between the partners
Liability of Partnerships
Unlimited liability where any partner can conduct business in the name of the entity and can make agreements that legally bind all partners without limits for the partnership’s debts
Limited Liability Partnership
A partnership where a partner cannot create a large liability for the other partners
Liability of LLP
Each partner is liable for partnership debts up to the extent of their investment plus their proportionate share of the liabilities
What does a LLP need to have?
An LLP must have one general partner with unlimited liability for all partnership debts
Limited Liability Corporation
Is one of which where the business is liable for the company’s debts
What are owners of an LLC called?
Members
Liability of an LLC
Members of an LLC do not have unlimited liability for the LLC’s debt
Does an LLC pay income tax?
They pay no business income tax
How do members of an LLC pay income taxes?
The LLC’s income flows through to the members and they pay income tax at their own tax rates just as if they were partners
Corporation
Is a business owned by the stockholders who own stock representing shares of ownership in the corporation
Advantages of Corporation
The ability to raise capital quickly by issuing stock to the public, the continuous life of a corporation, and the limited liability for stockholders
Liability of a Corporation
Stockholders have no personal obligations for the corporation’s debts. Therefore stockholders have limited liability of their investment
How is a corporation formed?
Is formed under state law
Double Taxation of Corporations
Corporations pay income taxes on profits and stockholders are taxed on their dividends
What are the voting rights of stockholders?
Stockholders usually get one vote for each share they own
What rights do stockholders have?
Stockholders elect a board of directors who set policy and appoint officers
General Accepted Accounting Principles
Accountants follow professional guidelines for measurement and disclosure of financial information
Financial Accounting Standards Board
In the United States they formulate GAAP
International Accounting Standards Board
Sets global financial reporting standards
Relevance
Information must be capable of making a difference to the decision maker. It must also be important enough to where if it was omitted it would make a difference in the user’s decision
Faithful Representation
The information must be complete, free from bias, and accurate. Makes the information relevant to users
Comparability
Means that the accounting information for a company must be prepared in a way to be compared with information of other companies in the same period and consistent with similar information for that company in other periods
Verifiability
Means that the information must be capable of being checked for completeness, accuracy, and reliability
Timeliness
Means that the information must be made available early enough to help them make decisions
Understandability
Means that the information must be sufficiently transparent so that it makes sense to reasonably informed users of the information
The Entity Assumption
Any organization that stands apart as a separate economic unit. Sharp boundaries are drawn around each entity to not confuse its affairs with those of others
The Continuity (Going-Concern) Assumption
The assumption that an entity will continue to operate long enough to use existing assets for its intended purpose
The Historical Cost Principle
States that assets should be recorded at their actual cost measured on the date of purchase as the amount of cash paid plus the dollar value of all non-cash considerations also given in exchange
The Stable Monetary Unit Assumption
Accountants assume that the dollar’s purchasing power is stable over time. We ignore inflation and this allows us to add and subtract dollar amounts as if the dollar had consistent purchasing power.
Accounting Equation
Assets= Liabilities + Owner’s Equity
Assets
Are economic resources that are expected to produce a future benefit
Examples of Assets
Cash, inventory, Equipment
Liabilities
Are outsider claims. They are debts that are paid to outsiders called creditors
Examples of Liabilities
Loans, anything payable
Owner’s Equity
Also called capital, or stockholder’s equity for a corporation. Represents the insider claims of a business. Equity means ownership in a business.
Paid in Capital
Is the amount the stockholders have invested in the corporation.
What is the basic component of paid in capital?
Common stock, which the corporation issues to the stockholders as evidence of ownership. All corporations have common stock
Retained Earnings
Is the amount earned by income producing activities and kept for use in the business.
What types of transactions that affect retained earnings?
Revenues, expenses, and dividends
Revenues
Are inflows of resources that increase retained earnings by delivering goods or services to customers
Expenses
Are resource outflows that decrease retained earnings due to operations. Represent the cost of doing business
Examples of Expenses
Cost of goods sold, rent, salaries, and utility payments.
Dividends
Decrease retained earnings because they are distributions to stockholder’s generated by net income
Net Income
Total revenues exceed total expenses
Net Loss
Total expenses exceed total revenues
Components of Retained Earnings
Beginning balance of retained earnings + net income or loss - dividends for the period = ending balance of retained earnings
What happens to net income on the statement of retained earnings?
Retained earnings is the net income kept over a period of years. Net income flows from the income statement to retained earnings
Current Assets
Are assets that are expected to be converted to cash, sold, or consumed during the next 12 months or within the business’s operating cycle if longer than a year
Examples of Current Assets
Cash and cash equivalents, short term investments, accounts and notes receivable, merchandise inventory, and prepaid expenses
Short Term Investments
Includes stocks and bonds of other companies that they intend to sell within the years
Accounts Receivable
Are amounts the company expects to collect from customers
Long Term (Non-Current) Assets
Assets that will not be used up within 12 months
Examples of Long Term Assets
Property, equipment, goodwill, and other large investments
Property and Equipment
Includes a corporations land, buildings, computers, store fixtures, and equipment.
How do corporations report property and equipment?
Corporations report property and equipment as net meaning their historical cost of the assets minus the accumulated depreciation
Intangibles
Are assets with no physical form such as patents, trademarks, and goodwill
Long Term Investmens
Are investments the company does not intend to sell within the next year
Current Liabilities
Are debts payable within one year
Examples of Current Liabilities
Accounts payable, accrued expenses, and federal income tax payable
Current Maturities of Long Term Debt
Represent the portion of long term liabilities that the company will have to pay within a year
Accounts Payable
Represents amounts owed to a company’s vendors and suppliers for purchases of inventory
Accrued Expenses
Interest payable on borrowed money, accrued liabilities for salaries, utilities, and other expenses a company has not yet paid
Income Taxes Payable
Are tax debts owed to the government
Common Stock
Represented by shares issued to stockholders. This amount represents the face amount of the stock
Additional Paid in Capital
Represents amount of cash received on initial sale of the company’s stock in excess of par value
Treasury Stock
Represents the amount paid by the company to repurchase its own stock
Accumulated Other Comprehensive Income (Loss)
Represents items of gain or loss that are allowed by the FASB to bypass the income statement and be recorded directly into stockholders equity
3 activities on the Statement of Cash Flows
Operating activities, financing activities, investing activities
Operating Activities
Companies operate by selling goods and services to customers. Operating activities result in net income or net loss. And they either increase or decrease cash
Investing Activities
Companies invest in long term assets. Both purchases and sales of long term assets are investing cash flows
Financing Activities
Companies need money for financing. Includes issuing stock, paying dividends, borrowing, and repayments of borrowed funds
Economic Factor
States the decision being made should maximize the economic benefits to the decision maker
Legal Factor
Is based on the preposition that free societies are governed by laws. Laws are written to provide clarity and to prevent abuse of the rights of individuals or society
Ethical Factor
Recognizes that while certain actions might be both economically profitable and legal, they may still not be right. Most companies have established standards for themselves to enforce a higher level of conduct than that imposed by law
Ethics
Are shaped by our cultural, socioeconomic, and religious backgrounds. An ethical analysis is needed to guide judgement for making decisions
What are total assets if total liabilities are $150,000 and stockholder’s equity is $150,000?
Total Assets= $300,000
What is total stockholder’s equity if total assets is $280,000 and total liabilities are $110,000?
Stockholder’s Equity = $170,000
What is total liabilities if total assets are $210,000 and stockholder’s equity is $160,000?
Total Liabilities = $50,000
How should ethics be incorporated into making accounting judgements?
Should be incorporated by asking if the action is legal? Who will be affected by the decision? And how will the decision make me feel afterward?
What forms of organizations would enable owners to limit the risks of loss to the amounts they have invested?
A corporation, limited liability partnership, or limited liability company
What form of business organization would give an owner the most freedom to manage the business as they wish?
Proprietorship
What form of business organization will give creditors the maximum protection in case a company fails and cannot pay their debts?
Partnership, because creditors can force the partners to pay the business debts from personal assets
Which accounting assumption governs mixing personal and corporate finances?
The entity assumption because it would allow everyone to understand the financial understanding of the company
If Wendy’s sells a store location to Burger King how can Wendy’s determine the actual sale price from the sale?
Historical cost principle, this principle states you report figures from when something is purchased and sold
If a company wants to measuring its land values in inflation adjusted amounts what assumption would they use?
Stable monetary unit assumption states the purchasing power of a dollar would remain stable over a period of time
General Motors wants to determine which division of the company is most profitable?
The entity assumption is used to determine the profits of different parts of the company
If you buy a $1200 computer for $500 what is the accounting value for this computer?
$500
How are assets and owner’s equity different from each other?
Assets are economic resources that are expected to provide future benefit while owner’s equity is the owner’s interest in the assets
How are liabilities and owner’s equity similar and different?
Liabilities are outside claims to assets as they are obligations to pay creditors. Owner’s equity are inside claims to show owner’s interest in assets
Accounts Payable
Liability
Common Stock
Owner’s equity
Supplies
Assets
Retained Earnings
Owner’s equity
Land
Assets
Prepaid expenses
Assets
Accounts receivable
Assets
Long term debt
Liability
Merchandise inventory
Asset
Notes payable
Liability
Accrued expenses payable
Liability
Equipment
Asset
Identify the two basic categories of items on an income statement
Revenues and expenses
What do we call the bottom line of the income statement?
Net income or net loss
What financial statements do dividends appear on?
Statement of retained earnings and statement of cash flows
What financial statement does salary expense appear on?
Income statement
What financial statement does inventory appear on?
Balance sheet
What financial statement does sales revenue appear on?
Income statement
What financial statement does retained earnings appear on?
Statement of retained earnings, balance sheet
What financial statement does net cash provided by operating activities appear on?
Statement of cash flows
What financial statement does net income appear on?
Income statement, statement of retained earnings, and statement of cash flows
What financial statement does cash appear on?
Balance sheet, statement of cash flows
What financial statement does net cash used for financing appear on?
Statement of cash flows
What financial statement does accounts payable appear on?
Balance sheet
What financial statement does common stock appear on?
Balance sheet
What financial statement does interest revenue appear on?
Income statement
What financial statement does long term debt appear on?
Balance sheet
What financial statement does an increase/decrease in cash appear on?
Statement of cash flows
How can a business earn large profits but have a small balance of retained earnings?
They could pay large dividends
Give 2 reasons as to why a business could have steady net income but have a cash shortage?
Heavy investing and paying off debts could reduce cash
If you could pick a single source of cash what would it be?
Collections from customers because it is the best way to get cash
How can a business be unprofitable and still have cash?
Borrowing, issuing stock, and selling assets
What financial statement does common stock appear on?
Balance sheet
What financial statement does ending balance of retained earnings appear on?
Statement of retained earnings and balance sheet
What financial statement does total assets appear on?
Balance sheet
What financial statement does adjustments to net income appear on!
Statement of cash flows
What financial statement does ending cash balance appear on?
Statement of cash flows and balance sheet
