Chapters 1-6 Flashcards
Qualities of useful information
- relevance
- faithful representation
relevance
- quality of useful info
- info that would make a difference in a business decision
- has predictive value – helps provide accurate representation about the future
- confirmatory value – confirms or corrects prior expectations
faithful representation
- quality of useful info
- info that accurately depicts what really happened
- complete – nothing important has been omitted
- neutral - not biased
enhancing qualities of useful info
- comparability
- consistency
- timeliness
- verifiability
- understandability
comparability
- enhancing quality
- difference companies use the same acct. prnciples - you can compare them
consistency
a company uses the same acct. pronciples and methods form year to year
verifiability
able to prove its free form error
timeliness
info must be available to decision makers in time to influence decisions
- annual reports must be submitted within 60 days of year end
understandability
presented in a clear and concise manner so users can interpret it
assumptions in financial reporting
- monetary unit assumption – only things that can be expressed in money are included in the financial statements
- economic entity assumption – keep separate personal transactions and company transactions
- going concern assumption – assume that the company will remain in operation for the forseeable future
- accrual basis – company records transactions in the period in which they actually took place
- periodicity assumption–the life of a business can be divided into artificial time periods
measurment principles
- cost principle — record assets at their cost (what they purchased them at)
- fair value principle– record assets and liabilities at fiar value (what they have depreiciated or risen to – what you will sell them at) – ex: stock
**FASB says that most things must follow the cost principle
*fair value is only used when assets are actively traded (ex: investments)
full disclosure principle
requires that companies disclose all events that would make a difference to financial statement users.
constraints in financial reporting
- materiality constraint – item is material when its size is likely to influence the decision of investor/creditor — it is immaterial if it wont affect a decision maker
*if item doesnt make a difference, company doesnt have to report it
-cost constraint – providig info is costly – weigh cost companies wil incurr by providing it against the benefit the financial users will gain from having the info available
intracompany comparisons
comparing the same company over 2 years
industry-average comparisons
based on average ratios for particular industries
intercompany comparisons
based on comparisons with a competitor within the same industry
source document
evidence of a transaction (sales slip, check, bill, cash register tape, etc.)
steps in recording process
- analyze each transaction
- enter transaction info in journal
- transfer journal information to the appropriate accounts in the ledger
benefits of general journal:
- it discloses in one place the complete effect of a transaction
- it provides chronoligcal record of transactions
- it helps prevent or locate errors because the debit and credit amounts for each entry can be easily compared
trial balance
- prepared at the end of the acct. period
- proves eqaulity of debits and credits
- accounts are listed in the order in which they appear in the ledger
- can uncover errors
- useful in the preparation of financial statements
but DOES NOT proves everything has been recorded or that it is correct
revenue recognition principle
companies recognize revenue in the accounting period in which it is earned (service is provided, sale is made)
expense recognition principle (matching principle)
efforts (expenses) must be matched with revenues
accrual basis accting
transactions that change a company’s financial statements are recorded in the periods in which the events occur - even if cash was not exchanged
- also recognize expenses when incurred
cash basis accting
companies record revenue when cash is recieved
- and record expense only when cash is paid
- PROHIBITED under GAAP
- because it violates the revenue recognition principle
adjusting entries
ensure that the revenue recognition and expense recognition principles are followed
- w/o these entries, trial balance may not include up to date data
- required every time a company prepares its financial statements
- every entry will include one income statement acct and one balace sheet acct
useful life
the period of service of an asset
depriciation
the process of allocating the cost of an asset to expense over its useful life
- allocates the asset’s cost to the period in which it was used
- DOES NOT attempt to report the actual change in value of an asset
book value
the difference between the cost of any depriciable asset and its related accumulated depreciation
ex: equipment minus accumuated depreciation of equipment = book value
steps
- journalize
- post to t-accounts in ledger
- prepare trial balance
temporary accounts
- revenue accounts
- expense accounts
- dividends
- because these only relate to a specific accounting period
permanent accounts
- all balance sheet accounts (assets, liabiiities, SE)
(because their balances are carried forward into the next accounting period)
closing entries
transfer net income (or loss) and dividends into Retained Earnings – to update RE to its correct ending balance
- companies close revenue and expense accounts in Income Summary
- then transfer this balance to RE
*dividends just go stright to RE
summary of accounting cycle (9 steps)
- for a whole year
- analyze transactions
- journalize them
- post to ledger (T accounts)
- prepare a trial balance
- journalize and post adjusting entries (deferrals and accruals)
- prepare adjusted trial balance
- prepare financial statements (IS, RE, BS)
- journalize and post closing entries
- prepare a post-closing trial balance
earnings management
the planned timing of revenues, expenses, gains, losses to smooth out the bumps in net income
quality of earnings
a company that has high quality of earnings will provide full and transparent info that will not confuse or mislead its users of financial statements
ways companies manage earnings
- use one-time items to prop up earnings numbers
- inflate revenue in teh short run to the detriment of the long run
- improper adjusting entries
- sarbanes-oxley act is working to improve this
categories of expenses for a merchandising company
- operating expenses
- costs of goods sold
operating cycle
operating cycle of merchandising company is longer than that of a service company
companies purchases in perpetual inventory system
- cash payments should have support of a cancelled check or cash register receipt
- each purchase should be supported by a purchase invoice, which indicates the total purchase price and other releant information
- purchaser uses copy of service invoice sent by seller
FOB shipping point
seller places the goods free on board the carrier, and the buyer pays the freight costs
–ownership passes to buyer when the item is shipped
FOB destination
-seller places the goods free on board to the buyer’s place of business, and the seller pays the freight
– ownership transfers when the buyer recieves the good
recording sales of merchandise in perpetual system
Accts Recievable - debit
sales revenue - credit
cost of goods sold - debit
inventory - credit
reasons to use single step income statement
- simple and easy to read
- a company does not realize any type of profit until revenues exceed expenses
gross profit
Net sales - COGS
- represents merchandising profit, NOT overall profit
COGS (under periodic inventory system)
Beginning Inventory + Purchases = Cost of goods availale for sale
COGAFS - ending inventory = COGS
gross profit rate
GPR = gross profit / net sales
- more meaningful than gross profit amount because it shows direct relationship b/w gross profit and net sales
Gross profit rate is a profitability measure. It measures how much a company profits off the sale of its inventory. Under most circumstances, the higher the number the better, as long as the company can sustain their sales levels. Gross profit rate shows how much a company is able to mark up their inventory when selling it, as well as how cheaply they can purchase their inventory. Gross profit rate is used to both compare year-to-year performance, as well as compare two companies within the same industry. Dayton’s GPR was slightly better in 2010 than 2011.
profit margin ratio
PMR = net income/net sales
- the percentage of each dollar of sales that results in net income
- can increase this by increasing gross profit or controlling its opperating expenses or other costs
quality of earnings ratio
net cash provided by operating activies / net income
- shows earnings quality
- a lotless than 1 = aggressive account practices to accelerate income recognition
- a lot greater than 1 = conservative accounting techniques
merchanidising company inventory
= merchandise inventory
manufacturing company types of inventory:
- raw materials - basic goods that will be used in production but are not in production yet
- work in progress- portion of manufactured inventory that has begun the production process but is not complete
- finished goods - manufactured items that are completed and ready for sale
- by looking at these levels, financial statement users can gain insight into a managers produciton plan
just-in time inventory
companies manufacture or purchase goods just in time for use
-need reliable suppliers
specific identification method
identifying which particular untis were sold and costing those at what they actually costed
- limited # of high cost items
- rare
cost flow assumptions
FIFO
LIFO
Average Cost
- assume flows of cost that may be unrealated to actual flow of goods
- many companies use periodic,
- very few perpetual users use LIFO FIFO or Avg cost (they use standard cost)
lower of cost-or-market
value inventory at lower of cost or market in the period in which a price decline occurs
- apply LCM after using one of the cost flow methods
= current replacement cost (not selling price)
