Chapter 2 Flashcards
What is the accounting equation
Assets= liabilities + equity
Balance sheet
info about resources available to management and claims against resources by creditors and shareholders
point in time
ending balance becomes beginning balance for next period
report yearly
Asset
Resource owned or controlled by a company and expected to provide economic benefits
What assets are reported on a balance sheet?
1) legal title, unrestricted access that are owned or controlled by company
2) future benefits (expected cash to sell product/service) that can be measured in monetary units
Liquidity
Ease of converting noncash assets into cash
Current asset
Most liquid assets, converted into cash or used in operations within the next year
Maintain liquidity to meet obligations and operate on daily basis but expensive to hold; maintain just enough to cover liquidity needs
Examples: cash/cash equivalent, marketable securities, accounts receivable, inventory, prepaid asset
Cash/cash equivalent asset
Current asset
currency, bank deposit, certificate of deposit, other
Marketable securities asset
Current asset
investments that can be quickly sold to raise cash
Accounts receivable asset
Current asset
amounts due to customers arising from past sale of product/service on credit
Inventory asset
goods purchased or produced for sale to customers, supplies for operating activities
Prepaid expense asset
Pay in advance for rent, insurance, other
Non-current assets
Long-term asset
Long term investments, property/plant/equipment (PPE), intangible and other
Long term asset
Non-current asset
debt securities or shares of other firms- management doesn’t plan to sell in the near term
Property, plant, and equipment (PPE) asset
Non-current asset
land, factory buildings, warehouses, office buildings, machinery, office equipment, other
Historical cost
Physical assets reported on balance sheet as reported on original acquisition cost
(+) reliability- amount paid to purchase asset is objective and accurately measured
(-) significantly undervalued, current value
Fair value cost
Current value obtained by quotes/sources; increases relevance- how useful is info
ex) marketable securities
Unrecognized internal asset
Logos, names- only reported if purchased by 3rd party; internally created
Liabilities
Firm’s obligation for borrowed funds from lenders or bond investors, obligation to pay suppliers, employees, tax authorities; interest bearing or non-interest bearing
probable future sacrifice resulting from current/past event; payment to creditor or promise to deliver good/service
When must a liability be reported
1) future sacrifice is probable
2) amount of obligation is known or easily estimated
3) transaction/event that caused obligation occurred
Executory contract
Future sacrifice is probable, amount of obligation is known or easily estimated BUT transaction hasn’t occurred yet
Equity
Capital that has been invested by shareholders directly or via purchase of stock or indirectly in the form of earnings reinvested in business and not paid out as dividends
Current liabilities
Due within 1 year or operating cycle
What kind of liability is accounts payable? What is accounts payable?
Current liability
amounts owed to suppliers for goods/services purchased on credit
What kind of liability is an accrued liability? What is an accrued liability?
Current liability
obligations for expenses that are recorded not paid; ex) wages owed but not paid, interest payable- interest in debt not yet paid, accrued taxes
What kind of liability is short term borrowings? What is a short term borrowing?
Current liability
short term debt payable to banks or creditors
What kind of liability is deferred (unearned) revenues? What is a deferred revenue?
Current liability
obligation created when company accepts payment in advance for future goods/services
What kind of liability is current maturities of long term debt? What is current maturities of long term debt?
Current liability
current portion of long term debt due to be paid in one year
Non current liabilities
Obligations after 1 year
Long term debt
Non current liability
amounts borrowed from creditors scheduled to be repaid in more than one year
Stockholders equity (SE) definition and types
Capital provided by shareholders
Common stock, additional paid in capital, treasury stock, retained earnings, accumulated other comprehensive income/loss
SE common stock
Contributed capital
Capital received from primary owners of company, divided into shares
SE additional paid in capital
Contributed capital
received from common shareholders in addition to stated value of common stock
SE treasury stock
Contributed capital
amount paid for common stock that company re-acquires, reduces contributed capital
SE retained earnings
Earned capital
accumulated earnings that haven’t been distributed to stockholders as dividends
SE accumulated other comprehensive income/loss
Earned capital
charges in equity not reported in income statement
Contributed capital
Net funding company received from issuing and re-acquiring shares- funds received less funds paid to repurpose
How do you calculate ending retained earnings?
Beginning retained earnings \+/- net income or net loss - dividends \_\_\_ ending retained earnings
Earned capital
Cumulative net income (or losses) retained by company- not paid as dividends, includes retained earnings and comprehensive income/loss
Account
Mechanism for accumulating effects of transactions/events, record if increase or decrease for asset, liability, equity, revenue, or expense
What are the 5 groupings of double entry accounting?
1) assets
2) liabilities
3) equity
4) revenues/income
5) expenses
What things are included in asset category?
Cash, accounts receivable, other receivables, inventory, prepaid insurance, security deposit, fixtures/equipment, accumulated depreciation- fixtures/equipment
What things are included in liability category?
Accounts payable, interest payable, wages payable, taxes payable, unearned revenue, notes payable
What things are included in equity category?
Common stock, retained earnings
What things are included in revenue/income?
Sales revenue, interest revenue
What things are included in expenses?
Cost of goods sold, wages expense, rent expense, advertising expense, depreciation expense- fixtures/equipment, insurance expense, interest expense, tax expense
What question is income statement trying to answer?
Did the business generate more resources than they used? *must have proper timing of revenue/expense
What do revenues result in an increase of?
Net assets (asset-liabilities) caused by transferring goods/services to customers
What do expenses result in a decrease of?
Net assets (asset-liabilities) caused by revenue-generating activities (COGs, depreciation, wages, debt interest)
What is the difference between revenues and expenses?
Net income or let loss
Operating expenses
Support the business- COGs, selling expense, depreciation, amortization, R&D; not all expenses are recognized in period in which cash is dispersed
depreciation: recognize when asset is used, not purchased
compensation: recognized when services are performed- before employees are paid
Non-operating expenses
company’s financing/investing activities including interest revenue/interest expense
Revenue recognition
Record when company transfers good/service to customer (expected value) even if no immediate increase in cash
Expense recognition
Recognized when assets diminish (or liabilities increase) as a result of earning revenue or supporting operations, even if no immediate decrease in cash
Accrual accounting
recognize revenue when earned through company’s operations and recognizing expenses as assets used and obligations incurred in carrying out operations
- balance sheet depicts resources and cash and obligations company must fulfill in the future
- required by GAAP
- exchange of cash is not the essential ingredient
Cost of goods sold
Cost of products delivered to customers during a period
Gross profit
Difference between revenues (@ selling price) and cost of goods sold (@ purchase price); remaining money to cover overhead and other expenses
Credit (on account)
sell product on account rather than for cash, seller still reports revenue; revenues reported when company “earned” sales- company has done everything under sales agreement
during sale: seller reports AR, revenue is recognized before cash collection
during cash collection: AR decreases, cash increases
How are net income and retained earnings related?
Net income is the change in returned earnings resulting from business activities during accounting period
Articulation
linkage between income statement and beginning/end of period balance sheets, achieved by tying net income to retained earnings
Executory contract
Doesn’t require entry, no earned revenue because hasn’t delivered product yet
Is revenue or income recorded from stock issuance?
No
Is expense recorded from dividend?
No
Statement of stockholders equity
Reconciliation of beginning and ending balances of selected stockholders equity accounts
Which side is debit on the t account?
Left
What side is credit on the t account?
Right
Compound entry
More than one debit/credit, total debits=total credits
Ledger
Listing of all accounts and dollar balances
Net working capital equation
Current assets- current liabilities
Cash operating cycle
Time between paying for goods and employee services and receipt of cash from sales/on creit
Current ratio
Current asset/current liabilities
If >1, positive net working capital
Higher ratio desirable if firms have difficulty predicting sales
Quick ratio
Cash+short term securities+accounts receivable/current liabilities
More restrictive form of current ratio- excludes inventories, only cash or near cash considered
