Double Entry Flashcards
What is double-entry accounting?
A system of book keeping where every entry into an account requires a corresponding and opposite entry into a different account.
What are the two equal and corresponding sides of double-entry?
debit and credit
What is the left-hand side?
debit
What is the right-hand side?
credit
What are some examples of a normally debited account?
An asset account or an expense account.
In a normally debited account, what happens with a debit and credit, respectively?
A debit increases the total quantity of money or value, and a credit decreases the amount/value.
What are some examples of a normally credited account?
A liability account or a revenue account
What rules must be true for every transaction?
Every transaction always affects at least two accounts, it always has at least one credit and one debit, and the total credit and total debit always are equal. This keeps the account equation in balance.
“<span>If a business takes out a bank loan for $10,000, how would you record the transaction?</span>”
Debit $10,000 from an asset account called ‘Cash’, credit $10,000 to a liability account called ‘Notes Payable’
Assets = ???
Assets = Liabilities + Equity
What does the accounting equation (Assets = Liabilities + Equity) tell us when it’s out of balance?
If the sum of all debit accounts doesn’t equal the sum of all credit accounts, an error has occurred.<br></br><br></br>However, the inverse isn’t true - even if debits are balanced with credits, there may still be errors if the wrong ledger accounts were debited or credited.
How is an audit trail preserved when entering debits and credits?
Entries that debit and credit related accounts include the same date and identifying number, so that if there’s an error, it can be traced back to a journal and transaction source document.
Does it matter which accounts and how many accounts are involved in any given transaction?
No, if done properly, the fundamental accounting equation that assets equal liability plus equity will always hold.
What are the two ways to memorize the effects of debits and credits on accounts in double-entry?
There’s the Traditional Approach, and the Accounting Equation Approach.
What’s another name for the Traditional Approach to memorizing the affects of Double Entry?
The Brittish Approach.
How are accounts classified within the traditional approach?
- Real<div>2. Personal</div><div>3. Nominal</div>
In the Traditional Approach, what are real accounts?
Accounts pertaining to assets and liabilities including the capital account of the owner.
Within the traditional approach, what are personal accounts?
Mainly debtors and creditors - people or companies with whom the business has transactions.
Within the traditional approach to double entry, what is a nominal account?
Revenue, expenses, gains and losses.
What are the golden rules of accounting within the Traditional Approach?
Real accounts - debit what comes in, credit what goes out.<div><br></br><div>Personal accounts - debit the receiver, credit the giver</div><div><br></br></div><div>Nominal accounts - debit all expenses & losses, credit all incomes and gains.</div></div>
What’s another name for the Accounting Equation Approach?
The American Approach
What are the five types the accounting equation approach classifies all accounts under?
CLEAR<div><br></br></div><div><div>1. Capital</div></div><div><div>2. Liabilities<br></br></div></div><div>3. Expenses / Losses<br></br></div><div>4. Assets<div>5. Revenues / Income</div></div>
In the Accounting Equation Approach, what is the rule for capital accounts?
Credit represents an increase in capital, debit is a decrease in capital.
In the Accounting Equation Approach, what is the rule for liability accounts?
A credit is a liability increase, a debit is a decrease.
“<div><div><div><div><span>Why does debit increase assets and decrease liabilities?</span></div></div></div></div>”
“It flows from the accounting equation: Assets = Liabilities + Capital.<br></br><br></br><div>Capital increases with credits and decreases with debits, so the other side of the equation must work opposite of that.</div><div><br></br></div><div>Let’s say you purchase an asset, say, a stapler. It’s $100 for the stapler. Those funds will come from capital, so there are zero liabilities.</div><div><br></br></div><div>Assets = Liability + Capital</div><div><span>Assets = 0 + (-100)</span></div><div><span>Assets = -100</span><br></br></div><div><span><br></br></span></div><div><span><br></br></span></div>”
What type of accounts are bank accounts normally treated as?
Generally, they’re treated as asset accounts.
What does the trial balance list?
All of the the nominal ledger account balances.
What matters more than the name of an account type?
Just its normal balance - whether that is debit or credit. The names have been taken over by marketing speak.
What type of accounts have a normal balance of debit?
Assets, expenses and drawings.
What type of accounts have a normal balance of credit?
Liability, revenue and capital accounts.
In which accounts do debits increase the balance?
Assets, Drawings and Expenses.
In which accounts do debits decrease the balance?
Liability, Revenue and Capital
Credits increase the balance of which accounts?
Liabilities, Capital and Revenue.
Credits decrease the balance of which accounts?
Assets, Drawings and Expenses.
What are debit accounts?
Accounts that usually have debit balances (the total debits usually exceed the total credits) (Assets and Expenses)
What are credit accounts?
Accounts that usually have credit balances (Capital, Revenue and LIabilities)
What is the acronym DEADCLIC?
DEAD: Debit increases Expense, Asset and Drawing accounts, CLIC: Credit increases Liability, Income, and Capital accounts.
What is the current equity?
Assets minus Liabilities
What is the sum of equity changes across time?
Owner’s investment (capital above) + Revenues - Expenses
What is a company’s Statement of Financial Position?
That’s just another word for Balance Sheet
What does a company’s balance sheet reveal?
The company’s assets, liabilities, and the owners’ equity (net worth)
What three parts make up the cornerstone of a company’s financial statements?
Their balance sheet, their income statement and their cash flow statement.
What are assets?
The means used to operate the company.
What are liabilities?
A company’s financial obligations.
What is the relationship between assets, liabilities, and equity in common english?
Assets are what the company runs the business with, liabilities and equity together are the two sources that support those assets.
What is the owners’ (or shareholders’) equity?
The amount of money initially invested into the company plus any retained earnings. This is the source of funding for the business.
What is a snap shot of company’s financial position at a single point in time called?
A balance sheet.
What are the two kinds of assets?
Current and non-current.
What is the lifespan of a current asset?
1 year or less.
What are some examples of current assets?
Cash, cash equivalents, accounts receivable, inventory.
What is included and considered as Cash as far as the balance sheet is concerned?
Non-restricted bank accounts and checks. (and, you know, straight cash)
What are cash equivalents, as far as the balance statement is concerned?
Things that can very easily be turned into cash: US Treasury bonds, for instance.
What does Accounts Receivable consist of as far as the balance sheet is concerned?
The short-term obligations owed to the company by its clients (products or services sold to a client on credit)
In which account are items sold on credit kept in until they are paid off?
Accounts Receivable.
What is inventory, within the balance sheet?
Raw materials, work-in-progress goods, and finished goods.
What are non-current assets?
Assets that aren’t turned into cash easily, aren’t expected to be turned into cash within a year, or have a lifespan of more than a year.
What are some examples of tangible assets?
Machinery, computers, buildings, land.
What are some examples of intangible assets?
Goodwill, patents, copyrights.
What is depreciation?
The economic cost of an asset over its useful life.
What are liabilities?
The financial obligations a company owes to outside parties.
What are long-term liabilities?
Debts and non-debt financial obligations that are due after a period of at least one year from the date of the balance sheet.
What are current liabilities?
Liabilities that will come due, or must be paid, within one year. This includes short-term borrowings (such as account payables), as well as the current portion of longer-term borrowing (such as the latest interest payment on a 10-year loan).
What is shareholders’ equity?
The initial amount of money invested in the business.
What happens if, at the end of the year, the company decides to re-invest any earnings (after taxes) into the company?
Those earnings move from the income statement to the balance sheet, and into the shareholders’ equity account.
What does the shareholders’ equity account represent?
A company’s total net worth.
What is the main technique to analyze the information contained on a balance sheet?
Financial ratio analysis
What is the debt-to-equity ratio?
It’s calculated by dividing a company’s total liabilities by its shareholder equity. This tells us a company’s financial leverage (i.e. How much the company is financing through debt, and how much through wholly-owned funds). This shouldn’t be above 2.0 (unless it’s mining and manufacturing)
How do you calculate working capital?
current assets - current liabilities
What does the working capital formula tell us?
A company’s liquidity, operational efficiency, and its short-term financial health.
What does a P&L statement show?
The revenues, costs and expenses incurred during a specific period (usually a fiscal quarter or year)
What does the P&L show?
A company’s ability (or inability) to generate profit by increasing revenue, reducing costs, or both.
What are some other names a P&L goes by?
Statement of Profit & Loss, Income Statement, Statement of Operations, Statement of Financial Results, Statement of Financial Income, Earnings Statement, or Expense Statement.
What are the three financial statements that every public company issues quarterly and annually?
The P&L, the balance sheet, and the cash flow statement.
What’s more important than the raw numbers of a P&L?
Comparing it to different time periods, to get the change in revenues, operating costs, R&D spending, and net earnings.
What is the most popular and common financial document within a business plan?
A P&L, because it quickly shows how much profit or loss was generated by a business.<div><br></br></div>
What is the biggest difference that the P&L and Cash Flow Statement have from a balance sheet?
The P&L and Cash Flow Statement show changes in accounts over a set period, where the balance sheet just shows a snapshot of what the company owns and owes at a given single moment in time.
Why is it important to compare the P&L with the Cash Flow Statement?
Because under the accrual method of accounting, a company can log revenues and expenses before cash changes hands.
What is the format of a P&L?
The top line has the revenue, then you have lines subtracting the costs of doing business (these include the cost of goods sold, the operating expenses, tax expenses and interest expenses)
What is on the bottom line of a P&L?
The Net Income (Revenue - Costs)
What does a Cash Flow Statement summarize?
The amount of cash and cash equivalents entering and leaving the company.
What does a Cash Flow Statement show about a company?
How well they manage their cash position and if they are generating enough cash to pay their debt obligations and fund their operating expenses.
What are the main components of a Cash Flow Statement?
Cash from operating activities, cash from investing activities, and cash from financing activities.
What are the two ways to calculate cash flow?
The Direct Method and the Indirect Method
What does a CFS let someone know?
How a company’s operations are running - where its money is coming from, and how that money is being spent.
What does a CFS show to a creditor?
Whether the company is on solid financial footing. How much cash is available (aka liquidity) for the company to fund its operating expenses and pay its debts.
How is a CFS distinct from a balance sheet or income statement?
It doesn’t include the amount of future incoming and outgoing cash that has been recorded on credit.
Are cash and net income the same thing?
Nah. Net income includes cash sales and sales made on credit.
What is cash from operating activities?
how much cash is generated from the company’s products or services.
What sort of things show up in cash from Operations?
Changes in cash, AR, depreciation, inventory, and accounts payable.
What might operating activities include?
- Receipts from sales of goods and services<div>2. Interest payments</div><div>3. Income tax payments</div><div>4. Payments made to suppliers of good and services used in production.</div><div>5. Salary and wage payments to employees.</div><div>6. Rent</div><div>7. Any other operating expense.</div>
What’s included in Cash from Operations under the indirect method?
Depreciation, Amortization, Deferred Tax, Gains or losses from a non-current asset, dividends and revenues from investing activities.
What is never included in Cash from Operations?
Purchases or sales from long-term assets.
How is cash flow calculated?
By making adjustments to net income by adding or subtracting differences in revenue, expenses, and credit transactions resulting from transactions that occur from one period to the next.
Why do many items have to be re-evaluated when calculating cash flow from operations?
Because not all transactions involve actual cash.
What does the direct cash flow method include in its calculations?
All types of cash payments and receipts - including cash paid to suppliers, cash receipts from customers, and cash paid out in salaries.<div><br></br></div><div>It uses the beginning and end balance of a variety of business accounts and examines the net increase or decrease.</div>
How do you calculate cash from operating activities with the indirect method?
You take the net income off of a company’s income statement. But we only recognize revenue when it is earned - not when it is received.<div><br></br></div><div>Net income isn’t an accurate representation of net cash from operating activities though - so we have to adjust earnings before interest and taxes (EBIT) for things that affect net income, even though no cash has been received or paid on them yet.</div><div><br></br></div><div>The indirect method then adds back non-operating activities that don’t affect a company’s operating cash flow.</div>
What is the only time that income from an asset is accounted for in the CFS
When the asset is sold
How does cash flow account for changes in AR from one accounting period to the next?
If AR goes down, that means more money has entered teh company from customers paying off their credit accounts - so that is added to net sales.<div><br></br></div><div>If AR goes up, that is deducted from the net sales because although that is revenue - it ain’t cash.</div>
In terms of inventory value and cash flow, what does it mean if inventory is increased?
That means a company spent more money to puchase more raw materials - if that was paid with cash, the value of that increase comes out of net sales, if there was a decrease, it adds to it.
What does it mean for cash flow if inventory is puchased on credit?
An increase in acccounts payable happens on the balancee sheet, and the amount of the increase is then added to net sales.
What does it mean, in terms of inventory value and cash flow, if something is paid off?
The difference in the value from one year to the next has to be subtracted from nt income. If there is still an amount owed - that difference is added to net earnings.
What does Cash from Investing Activities mean on a CFS
Any source and use of cash from a company’s investments - this includes changes in equipment, assets, or investments.
What are cash changes from an investment, usually?
“A ““cash out”” item - since cash is used to buy building and equipment and the like. When a company divests an asset, teh transaction is considered ““cash in”” and goes here.”
On a CFS, what does Cash from Financing include?
Sources of cash from investors and banks, as well as the uses of shareholders’ cash - payment of dividends, payments for stock purchases, and the repayment of debt principal.<div><br></br></div><div>It’s cash in when capital is raised, cash out when dividends are paid.</div>
How does the cash flow statement relate to the Income Statement and the Balance Sheet?
Net Earnings is the key to the CFS, and comes straight off the Income Statement.<div><br></br></div><div>Net Cash Flow from one year to the next should equal the increase or decrease of cash between the two consecutive balance sheets. So, to calculate cash flow for FY2019, you need the balance sheet for FY2018 and 2019</div>
What is Accounts Payable?
It’s an account within the general ledger that represents a company’s obligation to pay off short-term debt to its creditors or suppliers (this is the amount due to vendors or suppliers)<br></br><br></br>On the balance sheet, this is the sum of all outstanding amounts owed to vendors.
What does it mean if AP increases on a balance sheet over a previous period?
The company is buying more goods or services on credit, rather than paying cash.
What does it mean if a company’s AP decreases?
The company is paying on its prior period debts at a faster rate than it is purchasing new items on credit.
How do you offset accounts payable within double entry accounting?
You credit accounts payable when the bill is received, the debit offset for this entry is an expense account for the good or service purchased on credit. It could also be to an asset account if the item was purchased as a capitalizable asset.<div><br></br></div><div>When a bill is then paid, you debit accounts payable to decrease the liability balance, and credit the cash account, which decreases the cash balance.</div>
