Chapter 4 Flashcards
What is accounting
The process of measuring economic activity of a company in monetary terms and communicating the results to users
* so that can understand how the company performed.
who are the external users
External users: Investors, regulators, creditors
What does the 10k annual financial statement have
Includes: Financial statements, footnotes, management discussion and analysis, audit report
What is the basic accounting equation
Assets = Liabilities + Equity
Asset
the resources of the company (the things that the company owns)
ex: cash, buildings,etc
Liabilities
the obligations of the company (the things that the company owes)
Stockholder’s Equity
Ownership interest in the assets of the business after its liabilities have been settled
What is the accounting cycle
This describes the process of
1. analyzing transactions
- recording journal entries throughout the period,
- recording adjusting journal entries
- preparing annual financial statements
- and closing the temporary accounts into retained earnings after year end to prepare for the next year.
What is the expanded equation with it normal debit vs credit balances
Assets (debit) = liability (credit) + stockholders equity (credit)
stockholders quity = Common stock (credit) + retained earning (credit)
Retained earning= Revenue (credit) – expense (debit ) – dividend (debit
What is the general ledger ( T-account)
Show the effect transactions have on an account.
–> starts with the beginning balance and includes all transactions for the period and any adjusting entries to arrive at the ending balance.
–> Entries on the left are always debits and entries on the right are always credits
What is the trial balance
A listing of all accounts from the general ledger (T-accounts) with their ending debit or credit balance at the end of the period
*Unadjusted Trial Balance
*Adjusted Trial Balance
*Closing Trial Balance
What is preparing financial statements
The adjusted trial balance is used to prepare the Income Statement, Statement of Stockholders’ Equity, and the Balance sheet (Ignore Statement of Cash Flows)
What are permanent accounts
- Permanent accounts are accounts on the balance sheet (assets, liabilities, and stockholders’ equity)
What are temporary accounts? When are they closed? and how to close them?
- Temporary accounts are revenues, expenses, and dividends
–> Closing process: closing temporary accounts into retained earnings (which is a permanent account) T
–> This is only done at the end of the year after you have prepared your financial statements
o Debit each revenue account to remove its balance and credit retained earnings
o Credit each expense account and dividends and debit retained earnings
What are the financial statements?
- balance sheet
- income statement
- statement of cash flows
- income of stockholders equity
What is the balance sheet?
- Reports the company’s financial position as of a point in time. This statement is a snapshot of a company’s accounting equation (assets, liabilities, and equity) on a specific day
What are current assets ? How is it listed?
expected to be converted into cash or consumed within the company’s normal operating cycle or one year, whichever is longer
–> Listed in order of expected liquidity (Ex. Cash, short-term investments, accounts receivable, inventory, other current assets)
–> liquidy = is how quickly the asset can be converted into cash, cash is always the first asset listed because it is the most liquid asset a company owns
What are noncurrent assets
assets the company does not expect to convert into cash during the normal operating cycle, or one year, whichever is longer
- Ex. Property plant and equipment, intangible assets, and other long-term assets
What are current liabilities
Obligations that must be settled within the normal operating cycle or one year, whichever is longer.
- Listed in order of maturity (Ex. Accounts payable, accrued expenses payable, short-term notes payable, other current liabilities)
- Maturity= Maturity is how quickly that obligation will be required to be paid. The liabilities that you owe sooner, will be listed first.
–> The ones you have a little longer to pay will be listed lower. Accounts payable is typically the first liability listed
What are long term liabilities
Obligations that are not due to be settled within the normal operating cycle, or one year, whichever is less
- (Ex. Long-term notes payable, bonds payable, other long-term liabilities)
What is stockholders equity?
Contributed capital (common stock) and retained earnings (increased by net income for the current period and decreased by dividends paid)
What is an income statement ? What does it contain?
*Reports the company’s revenues and expenses for a given period of time
*Revenue minus expenses = net income
iWhat is a multu-income statement
A multi-step income statement provides a detailed breakdown of a company’s financial performance by separating operating and non-operating activities, using multiple equations to calculate net income, gross profit, and operating income, unlike a single-step income statement.
- Income from operations (+/-) other income and expenses, net = Pretax Income
- Pretax Income – income tax expense = Net Income
What is a single step income statement
- a simplified financial statement that summarizes a company’s revenue and expenses, directly calculating net income (or loss) by subtracting total expenses from total revenues in a single step.
- This form is less common given it does not give you the additional detail on how much income was earned from the core business and how much was earned from “other” activities the business participated in.
What is the difference between multi-step and single-step income statement ?
- If the company placed some of their excess cash in an investment to earn interest income, the interest income would be in the other section for a multi-step income statement.
–> This separates the interest income out from the income related to the business so we can have a subtotal that tells us how much income came from the company’s operations before we consider the “other” business activities they participated in.
–> Note, either method will have you arrive at the same net income number, the multi-step income statement just gives you more useful information about the company. It allows you to understand better about how the business performed
What is the statement of stockholders equity
*Shows the events that led to increases/decreases in the company’s stockholder’s equity during a given period of time
Includes:
- Common stock
- Retained earnings: Beginning retained earnings + Net income for the period – dividends paid to stockholders = ending retained earnings)
how to calculate retained earning
Beginning retained earnings + Net income for the period – dividends paid to stockholders = ending retained earnings)
statement of cash flow?
- Reports cash inflows (cash coming into the company) and cash outflows (cash paid by the company) for a given period of time
What is the Relationship among financial statements?
- Net income from the income statement is included on the statement of retained earnings (Current year net income is added to calculate ending retained earnings)
- Ending common stock, retained earnings and total equity from the statement of stockholder’s equity is on the balance sheet
- The ending cash balance on the statement of cash flows is on the balance sheet
What is an audit
Purpose of an audit – have an independent party assess if the financial statements are prepared correctly and show an accurate picture of how the company performed for the year.
–> They also test the company’s internal controls to ensure they are designed properly and operating as they should be.
What is accrual basis of accounting
- Revenue is recorded as it is earned and expenses are recognized as incurred. This is the method required by US GAAP.
What is revenue recognition
- Revenue is recognized when you have completed the service/provided the product to the customer.
–> Once the performance obligation for the revenue is complete, the revenue is recognized regardless of when cash is received.
What is the expense matching principle ?
*Expenses incurred to generate revenues must be recognized in the same period as the revenue
*It is the recognition of revenue, and not the payment of cash, that determines when expenses are recognized
What is double entry accounting
Each accounting transaction affects at least two elements of the accounting equation (ensures the accounting equation remains in balance)
what is accrued expense?
Recording expenses that have not yet been paid in cash (Liabilities increase and expense increases)
–> Ex. Rent payable, interest payable, salaries payable, utilities payable
What is accrued revenue ?
Recording revenues that cash has not yet been received
ex: Asset (Accounts Receivable) increases and revenue increases
How do you adjust prepaid expenses?
Allocating a previously recorded asset to expense (asset decreases and expense increases)
–> Ex. Booking one month’s worth of rent expense out of the prepaid rent account
o Ex. Booking depreciation expense for PPE
how do you adjust for unearned revenue
Allocating previously recorded unearned revenue to revenue (once you have completed the obligation)
- Liability (unearned revenue) decreases and revenue increases
What is internal control?
Internal control refers to the measures a company takes to ensure the reliability of its financial data, protect assets from unauthorized use, and ensure compliance with policies and procedures.
What are the reasons for incorrect financial statements?
Errors: Accidental mistakes in recording transactions.
Fraud: Intentional deception for personal gain.
Occupational fraud: Using one’s occupation to commit fraud.
What are the types of fraud
- Embezzlement of cash
- Theft of assets
- Filing false insurance claims
- Financial statement fraud
Who is capable of committing fraud?
Anyone can commit fraud under the right circumstances.
What are the components of the fraud triangle?
- Pressure
- Rationalization
- Opportunity
What is the significance of pressure in the fraud triangle?
Most fraud is committed due to financial pressure, such as the need to meet expectations or personal financial struggles.
What is rationalization in the context of fraud?
The act of justifying dishonest actions to overcome feelings of guilt. For example, an employee may justify stealing because they feel they deserve the money.
What does opportunity in the fraud triangle mean?
It’s the perception that there is a chance to commit fraud without getting caught.
What attributes to good internal control
- Segregation of duties (the following should be separated: authorization, recording, custody)
- Physical controls (ensure assets and accounting records are sage)
- Proper authorization (have policies in place outlining who can authorize transactions)
- Perform a risk assessment and continue to monitor how the company changes over time to adapt controls to the risks of the business
What is the purpose of a bank reconciliation?
A bank reconciliation ensures that the company’s cash balance matches the bank’s balance by adjusting for timing differences, deposits in transit, and outstanding checks.
How do you perform a bank reconciliation?
- Start with the bank’s ending balance and add deposits in transit and corrections made by the bank.
- Subtract outstanding checks and other corrections from the bank.
- Do the same for the company’s general ledger, ensuring both balances match.
What are accounts receivable?
Accounts receivable represents the money customers owe for goods or services already provided by the company.
How is an uncollected portion of accounts receivable treated?
The uncollected portion is considered a credit loss and recorded as Bad Debt Expense (debited) and an allowance for doubtful accounts (credited).
What is the allowance method?
The allowance method is a GAAP-required approach where companies estimate uncollectible accounts and record a contra asset account to reduce accounts receivable.
How is the allowance for doubtful accounts estimated?
The allowance is estimated based on past experience, current economic conditions, and company history, and it is typically done quarterly or annually.
What is the journal entry to record bad debt expense using the allowance method?
Bad Debt Expense (Debit)
Allowance for Doubtful Accounts (Credit)
How is accounts receivable presented on the balance sheet after applying the allowance method?
Accounts Receivable
Less: Allowance for Doubtful Accounts
Accounts Receivable, Net (showing the expected collectible amount)
What do you write down what estimating amount of accounts receivable that will be uncollected
Debit: Bad Debt Expense
Credit: Allowance for doubtful accounts
How to adjust book balance?
- Add: items recorded as cash receipts by the bank but not yet recorded in company’s books
- Add: any corrections not yet made by the company that will increase the general ledger cash balance
- Subtract: items recorded as cash disbursements by the bank but not yet recorded in the company’s books
- Subtract: any corrections not yet made by the company that will decrease the general ledger cash balance (ex. NSF check)
What is the book balance adjustment
- Adjustments to the book balance need to be booked as journal entries to bring our book balance to the reconciled cash balance. The point of the bank reconciliation is to ensure the cash balance we show on the financial statements is correct, performing the reconciliation gets us to the correct cash balance but we then need to post the journal entries that are adjustments to the book balance so that is the number within our accounting records.
How would record a Write-off specific accounts once it is determined they will not be collected
Debit: Allowance for doubtful accounts
Credit: Accounts Receivable
What are methods to use when estimating uncollectable accounts?
- Percentage of receivables: accounts based on a predetermined percentage of the total accounts receivable.
–> multiply the total accounts receivable at the end of the period by the predetermined estimated uncollectible percentage. Once you have the eding allowance for uncollectible accounts amount, you will have to create a T-account to calculate the amount of the bad debt expense adjusting journal entry to record - aging method: estimates bad debts based on the age of accounts receivable, applying higher percentages for older accounts since they are less likely to be collected.
–> Once you have the ending allowance for doubtful accounts balance, you will have to calculate the bad debt expense amount to book for the adjusting journal entry by using the T-account.
What is net revenue?
Net revenue=
total revenue - ( any returns, allowances, and discounts given to customers.)
What is sale return and how do you record it?
- your customer is returning goods to you
- Debit Sales returns (Contra revenue) and credit accounts receivable
–> This is reversing the first entry listed above (Revenue and AR) - Debit Inventory and credit cost of goods sold
–>This is bringing the returned goods back into your inventory balance and removing the expense from the income statement
What is sale discount and how do you record it?
that you are giving to your customer that is purchasing your goods
–> an incentive for customers to pay early, reducing the amount owed if payment is made within a specified period, like “2/10, n/30.”
- Cash (Debit)
Sales Discount (Debit)
Accounts Receivable (Credit)
–> This entry reduces the amount the customer owes the seller to zero, the seller is just receiving slightly less because they gave the customer a discount
what is sale revenue ; where is it presented?
net is presented on the income statement.
calculated by taking total revenue – (minus) all contra revenue accounts (sales returns, sales allowances, and sales discount
How do sale returns and allowances affect financial statements
Sale returns and allowances are contra revenue accounts, reducing reported revenues but not treated as expenses.
What is the journal entry to record the collection of notes receivable with interest?
Cash (Debit)
Notes Receivable (Credit)
Interest Revenue (Credit)
what is notes recievable
Notes receivable are written promises for amounts to be received in the future, which may include interest. They are classified as either current or noncurrent assets.
How is interest accrued for notes receivable?
Interest is accrued by recognizing interest revenue in the accounting period it is earned, even if cash has not yet been received. This is done with an adjusting entry for Interest Receivable and Interest Revenue.
What is the receivables turnover ratio?
The receivables turnover ratio measures how many times the company collects its average accounts receivable balance during the year.
Formula:
Receivables Turnover Ratio = Net Credit Sales / Average Accounts Receivable
What is the average collection period?
The average collection period is the number of days it takes on average to collect an account receivable.
Formula:
Average Collection Period = 365 days / Receivables Turnover Ratio
What is a sales discount with terms 2/10, n/30?
sales discount with terms 2/10, n/30 means that the customer gets a 2% discount if they pay within 10 days, but the full amount is due in 30 days without a discount.
What is inventory in a company?
Inventory is the items a company intends to sell or has already sold to customers. It is typically reported as a current asset on the balance sheet.
–> inventory balance includes all costs to get it ready for sale (shipping increases your inventory balance if you paid for it, any discount you receive or any amount you return reduces the inventory balance)
ow does inventory relate to the cost of goods sold (COGS)?
Inventory is impacted by sales or additional inventory purchases. When inventory is sold, it moves from the inventory account to the COGS expense account.
What are the journal entries when inventory is sold?
ex: Revenue Journal Entry
- Cash/Accounts Receivable 250
Revenue 250 - COGS Journal Entry
COGS 100
Inventory 100
What is FIFO (First-In, First-Out)?
FIFO assumes that the first items purchased are the first to be sold. For example, in a grocery store, the first eggs purchased are the first to be sold.
How does LIFO (Last-In, First-Out) work?
LIFO assumes that the last units purchased are the first to be sold, meaning newer inventory is sold first.
What is FOB shipping point (Free on Board) shipping point?
Buyer is responsible for shipping costs
What is FOB Destination
When the title of goods passes to the buyer when the seller ships the inventory.
–> Seller is responsible for shipping costs
What is the weighted average cost method?
This method assumes that each unit of inventory has a cost equal to the weighted average unit cost of all inventory items available for sale.
Why would a company choose FIFO?
FIFO reflects the actual physical flow of goods, particularly for perishable items. It results in higher ending inventory and lower COGS when prices are rising.
What is the perpetual inventory system?
This system continuously updates inventory records after every purchase or sale, helping with internal controls and decision-making.
What is the difference between capitalizing and expensing an asset after acquisition?
Capitalize if the asset provides future benefits (e.g., creating a new wind for study rooms).
Expense if the asset maintains its original functionality (e.g., repairing a desk leg).
What is straight-line depreciation?
Straight-line depreciation spreads the cost of the asset evenly over its useful life, factoring in the residual value.
–> Acquisition cost – Salvage or residual value)/ Estimated useful life in years
What is double-declining balance depreciation?
This method records more depreciation in the early years of the asset’s life, using twice the straight-line rate.
–> Multiply the double declining rate by the net book value of the asset at the beginning of the year to calculate each year’s depreciation expense
o Double declining rate = (2/useful life)
o Beginning book value = Acquisition cost – accumulated depreciation
What is amortization?
Amortization is the process of allocating the cost of intangible assets (like patents and trademarks) to expense over their useful lives, usually using the straight-line method.
What is goodwill?
Goodwill is the excess of the purchase price over the net assets (assets minus liabilities) when acquiring a company. It is not amortized but tested for impairment.
–> will never be depreciated
What is activity based costing method
Multiply the number of units used in the year by the depreciation by unit rate calculated.
o Depreciation per unit = (Acquisition cost – salvage value)/estimated useful life in units
o Multiply the depreciation per unit by the number of units used each year
What is the formula for the return on assets (ROA) ratio?
Return on Assets = Net Income / Average Total Assets. It shows how much profit a company generates for each dollar invested in assets.
How do you record for Disposal of PPE
- Remove asset’s original cost
- Remove accumulated depreciation
- Record cash received
- Record any gain or loss (Difference between proceeds received and the book value of the asset on the day of the sale)
What is Property, Plant, and Equipment
Every tangible asset you own
Recorded at: the original cost of the asset + all expenditures necessary to get the asset ready for use
What is Basket Purchases
Purchase of more than one asset at the same time for one purchase price
We need to record each of the assets acquired ( Ex: land, building, and equipment) in separate accounts
What are intangible assets
Assets that are not physical but still provide a benefit to the company Ex: copyright, patent, trademarks, goodwill
The way we account those intangible assets depends on the way we obtain them whether it is purchasing or internally developing them
Internally developing: regular research to create a product
How do we record the disposal of PPE ( propert, plant, and equipment)
- Remove asset’s original cost
- Remove accumulated depreciation
- Record cash received
- Record any gain or loss (Difference between proceeds received and the book value of the asset on the day of the sale)
What are * Future costs related to PPE (after it has already been purchased
o Repairs and maintenance are expensed right away (debit repairs and maintenance expense credit cash)
- These are costs to keep the asset working at the original
