exam 1 Flashcards
common types of current assets
cash, investments, receivables, inventories, and prepaid expenses
long term investments
investments in stocks and bonds of other corp. that are held for more than a year, long term assets such as land or buildings that a company is not currently using to operate, and long term notes receivable
property, plant, and equipment
assets with long useful lives currently used in operating the business
intangible assets
goodwill, patents, copyrights, and trademarks
current liabilities
obligations that the company is to pay within the operating cycle
long-term liabilities
company will pay after the operating cycle; include bonds payable, mortgages payable, long-term notes payable, lease liabilities, and pension liabilities
profitability ratios (earnings per share)
- measures the operating success of a company for a given period of time
- measures income earned on each share of common stock
- (net income - preferred dividends)/weighted outstanding shares
working capital
- measure of liquidity
- curent assets - current liabilities
current ratio
- more reliable measure of liquidity
- current assets / current liabilities
- determines if a company can reach its near term obligations
- result is the amount of assets the company has compared to every dollar of liabilities
solvency ratios
- measures the ability of the company to survive over a long period of time
- solvency is the company’s ability to pay interest as it’s due and to repay the balance of a debt
debt to assets ration
- total liabilities / total assets
- measures the percentage of total financing provided by creditors
- higher percentage means more risky because it shows how much they rely on debt
free cash flow
- describes the net cash provided by operating activities after adjusting for capital expenditures and dividends paid
- net cash - capital expenditures - cash dividends (or whatever it was spent on)
GAAP
- generally accepted accounting principles
- set of accounting standards
SEC
- securities and exchange commission
- oversees financial markets and accounting standard setting bodies
FASB
- financial accounting standards board
- primary accounting standard setting body
IASB
- international accounting standards board-
- issues standards called IFRS (international financial reporting standards)
relevance
acct info has relevance if it makes a difference in a business decision and has predictive value and confirmatory value
predictive value
helps provide accurate expectations about the future
confirmatory value
confirms or corrects prior expectations
materiality
- company specific aspect of relevance
- an item is material when its size makes it likely to influence an investor or creditor
faithful representation
- information accurately depicts what really happened
- must be complete, (nothing important has been omitted) neutral, (is not biased toward one position or another) and free from error
comparability
different companies use the same accounting principles
consistency
a company uses the same accounting principles and methods from year to year
verifiable
info is verifiable when independent observers, using the same methods, obtain similar results
for info to be relevant it must be timely:
must be available to decision-makers before it loses its capacity to influence decisions
understandability
when info is presented in a clear and concise fashion, so that reasonably informed users of that information can interpret it and comprehend its meaning
fiscal year
accounting period that is one year long (doesn’t always have to end on dec. 31)
monetary unit assumption
requires that only things that can be expressed in money are included in the accounting records
economic entity assumption
- every economic entity can be separately identified and accounted for
- to maintain economic entity it’s important to not blur company transactions with personal transactions or those of other companies
periodicity assumption
states that the life of a business can be divided into artificial time periods and that useful reports covering those periods can be prepared for the business
going concern assumption
states that the business will remain in operation for the foreseeable future
historical cost / cost principle
- companies record assets at their cost even if it changes over time
- most assets follow this because market info might not be representationally faithful
fair value principle
- assets and liabilities should be reported at their fair value
- the price received to sell an asset or settle a liability
- market information is readily available
- relevance and faithful representation are used to decide between fair value and cost principles
- used when assets are actively traded
full disclosure principle
requires that companies disclose all circumstances and events that would make a difference to financial statement users
cost constraint
- used to decide if a company should include a certain type of information
- weighs the cost of the information with the benefit the users of the financial statements will gain from having the information
accounting information system
- system of collecting and processing transaction data and communicating financial information to decision-makers
- the nature of the company’s business, the types of transactions, the size of the company, the volume of data, and the information demands of management and others shape the accounting system
accounting cycle
- analyze transactions
- journal entries
- post entries
- trial balance
- journal adjusting entries
- post adjusting entries
- adjusted trial balance
- financial statements
- closing entries
- post closing trial balance
accounting transactions
anything that affects assets, liabilities or stockholders’ equity and therefore would be recorded
transaction analysis
process of identifying the specific effects of economic events on the accounting equation
expenses and dividends in the accounting equation
expenses and dividends DECREASE stockholders equity, but paying for an expense or paying a dividend is considered an INCREASE in expenses and dividends
prepaid expenses
recorded as an asset because it will benefit more than one accounting period
account
individual accounting record of increases and decreases in a specific asset, liability, stockholders’ equity, revenue, or expense item
T account
name of account at the top, debit on the left, credit on the right
debits and credits
- describe where entries are made in an account
- must equal each other for every transaction
debit and credit balances
- if the debit side exceeds the credit side, it is a debit balance
- if the credit side exceeds the debit side, it is a credit balance
double entry system
two-sided effect of each transaction is recorded in appropriate accounts to ensure the accuracy of the recorded amounts
dr/cr assets
- increase in assets is a debit
- decrease in assets is a credit
dr/cr liabilities
- increase in liabilities is a credit
- decrease in liabilities is a debit
normal balance
the side where increases in the account are recorded
dr/cr common stock
- increase in common stocks is a credit
- decrease in common stocks is a debit
dr/cr retained earnings
- increase in retained earnings is a credit
- decrease in retained earnings is a debit
dr/cr dividends
- increase in dividends is a debit
- decrease in dividends is a credit
dr/cr revenues
- increase in revenues is a credit
- decrease in revenues is a debit
dr/cr expenses
-increase in expenses is a debit
-decrease in expenses is a credit
(remember that even though an expense means less money, it is still considered an increase in the expense account)
locations of the subdivisions of stockholders’ equity on financial statements
- common stock and retained earnings on the balance sheet
- dividends on the retained earnings statement
- revenues and expenses on the income statement
source document
- comes in the form of a sales slip, a check, a bill, or a cash register document
- evidence of a transaction
- analyzed to determine the effect on a specific account
- journal it then add it to the ledger
journal
accounting record where transactions are recorded chronologically
ledger
- group of accounts maintained by a company
- provides the balance of all accounts and keeps track of any changes in the accounts
chart of accounts
list of a company’s accounts
posting
transferring journal entries to a ledger
trial balance
- list accounts and their balances at that time
- companies provide them at the end of their accounting period
- accounts are listed in the order they appear on the ledger
- proves that debits equal credits
order of accounts in trial balance
- assets
- liabilities
- stockholders’ equity
- revenues
- expenses
error vs. irregularity
- error is an unintentional mistake
- irregularity is intentional and viewed as unethical
operating activities
- activities a company performs to generate profits
- relate to cash received or cash spent to support its’ services
investing activities
- purchase or sale of long lived assets used in operating the business
- purchase or sale of stocks/bonds in other companies
- purchasing of equipment or land
financing activities
borrowing money, issuing stock and paying dividends
revenue recognition principle
- requires that companies recognize revenue in the accounting period in which the performance obligation is satisfied
- for example, if a company performs a service in june but will not be paid until july, it still records the revenue in june since that’s when they completed it
- we would record the payment in june as a receivable
expense recognition principle
-dictates that expenses be matched with revenues
accrual basis accounting
transactions that change a company’s financial statements are recorded in the periods in which the events occur, even if cash was not exchanged
cash basis accounting
- companies record revenue at the time they receive cash and expenses at the time they pay out cash
- can often form misleading financial statements
- not in accordance with GAAP
adjusting entries
- ensure that the revenue recognition and expense recognition principles are followed
- necessary because the trial balance may not include up to date data
- each adjusted entry requires one income statement account and one balance sheet account
- no effect on cash flows
2 types of adjusting entries
deferrals and accruals
deferral entries
prepaid expenses and unearned revenues
accrual entries
- accrued revenues (revenues for services performed but not yet received in cash or recorded)
- accrued expenses (expenses incurred but not yet paid in cash or recorded)
defer
postpone or delay
deferrals
costs or revenues that are recognized at a date later than the point when cash was originally exchanged
prepaid expenses
- expenses paid in cash before they are used or consumed
- costs that expire with the passage of time or through use
- do not require daily entries
- wait until the statement date to record the expenses applicable to the accounting period to show the remaining amount in the assets account
depreciation
- process of allocating the cost of an asset to expense over its useful life
- for example, when you buy a building it will be useful for many years. you record the cost of the building but you also record a portion of the cost as an expense as depreciation over time
- does not change the actual value of the asset
contra asset account
an account that is offset against an asset account on the balance sheet
accrued revenues
- revenues for services performed but not yet recorded at the statement date
- adjusting entry results in a debit to an asset account and a credit to a revenue account
accrued expenses
expenses incurred but not yet paid or recorded at the statement date
amount of interest recorded
face value X interest rate X length of outstanding note (number of months divided by 12)
quality of earnings
indicates the level of full and transparent information that a company provides to users of its financial statements
temporary accounts
revenues, expenses and dividends
permanent accounts
assets, liabilities and stockholders’ equity
closing entries
entries at the end of an accounting period to transfer the temporary accounts to the permanent account–retained earnings
sole proprietorship
- business owned by one person
- simple to set up
- gives you control
- good tax treatment
partnership
- business owned by two or more people associated as partners
- often formed because one partner doesn’t have enough resources
- good tax treatment
corporation
- business organized as a separate legal entity owned by stockholders
- easier to raise funds
- less liability
internal users
- managers who plan, organize, and run a business
- marketing managers, production supervisors, finance directors and company officers
external users
- investors use accounting information to make decisions to buy, sell or hold stock
- creditors use accounting information to evaluate the risks of selling on credit or lending money
Sarbanes Oxley Act (SOX)
regulations passed by congress to reduce unethical corporate behavior
