Exam 1 Flashcards
GAAP
Generally accepted accounting principles; a set of rules and practices that have authoritative support; FASB (financial accounting standard board) determines GAAP; SEC (securities and exchanges commission) enforces it
Two primary qualities of useful accounting information
Relevance and faithful representation
Five enhancing qualities of useful accounting information
Comparability, consistency, verifiability, timeliness, and understandability
Two characteristics of relevance
Predictive value, confirmatory value
Three characteristics of faithful representation
complete, neutral, free from error
Materiality
relates to a financial statement item’s impact on a company’s overall financial condition and operations; material- its size makes it likely to influence the decision of an investor or creditor; immaterial- if it is too small to impact a decision maker; if it does not make a difference, the company does not need to follow GAAP in reporting it
Economic entity assumption
a business is a separate entity from its owner; financial transactions of a business are maintained separately from those of its owners personal transactions
Going concern assumption
assumes that a business will continue its operations for the foreseeable future when recording and reporting data (historical cost is related to this)
Monetary unit assumption
all transactions in the US are recorded in dollars and the financial statements only include those things that can be expressed in money (things such as customer satisfaction not included, and other important information)
Periodicity assumption
managers, owners, and others need periodic reports on the operations and financial conditions of a business in order to make informed decisions; the life of a business can be divided into artificial time periods for measurement and reporting purposes
Accrual basis assumption
transactions are recorded in the period in which the event occurs, not necessarily when the cash is received
Full disclosure principle
financial statements and notes should disclose all of the circumstances and events that would make a difference to financial statement users to aid them in fully understanding a company’s financial condition
Fair value principle
assets and liabilities should be reported in the statements at their fair value (what an item is worth and what would need to be paid to settle a liability)
Cost principle
assets are to be recorded and kept in the accounting records at their historical cost
Materiality constraint
accountants must follow GAAP for all material items reported in a company’s financial statements; immaterial items do not have to follow GAAP
Cost constraint
account standard-setters weigh the cost that companies will incur to provide the accounting information against the benefit that financial statement users will gain
Four things that affect stockholders’ equity
Revenues- increase, expenses- decrease, dividends- decrease, issuance of common stock, increase (REDI)
Accounting equation and how to find missing amounts
A = L + SE (CS + RE)
Debit
left side of an account (Dr.)
Credit
right side of an account (Cr.)
Double-entry accounting
the two-sided effect of each transaction is recorded in appropriate accounts; equality of debits and credits
Debits increase
expenses, assets, dividends (DEAD)
Credits increase
liabilities, revenues, stockholders’ equity (CLRS)
Transaction recording process steps
- analyze each transaction in terms of its effect on the accounts 2. enter the transaction information in a journal 3. transfer the journal information to the appropriate accounts in the ledger
Journal
for each transaction the journal shows the debit and credit effects on specific accounts; 1. discloses in one place the complete effect of a transaction 2. chronological record of transactions 3. helps to prevent or locate errors
Ledger
entire group of accounts maintained by a company; keeps in one place all the information about changes in specific account balances; general ledger contains all the assets, liabilities, stockholders’ equity, revenue, and expense accounts
Chart of accounts
Order: assets, liabilities, stockholders’ equity, revenues, and expenses; list of accounts
Journalizing
Entering transaction data in the journal; complete entry includes: 1. the date of the transaction 2. the accounts and amounts to be debited and credited 3. a brief explanation of the transaction; date is entered in date column, account debited is entered first at the left, account credited is indented on the next line under, debit column is left and credit column is right; important to use correct and specific account titles
Posting
process of transferring journal entry amounts to ledger accounts; accumulates the effects of journalized transactions in the individual accounts; steps: 1. date and debit amount shown in journal in appropriate columns of debit account 2. same for credit accounts
Trial balance
lists accounts and their balances at a given time; end of accounting period; in the order in which they appear in the ledger; debit amounts in left column and credit balances in the right column; debits and credits must be equal; may uncover errors in journalizing and posting; useful in preparation of financial statements; procedures: 1. list the account titles and their balances 2. total the debit column and credit column 3. verify the equality of the two columns
Errors in which the trial balance would still balance
- a transaction is not journalized 2. a correct journal entry is not posted 3. a journal entry is posted twice 4. incorrect accounts are used in journalizing or posting 5. offsetting errors are made in recording the amount of a transaction; as long as debits and credits are equal, even to the wrong account or in the wrong amount, the total debits will equal the total credits
Profitability ratios
Measure the operating success of a company for a given period of time; Earnings per share
Solvency ratios
measure the ability of the company to survive over a long period of time; Debt to total assets ration
Liquidity ratios
Measure short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash; Working capital, current ratio
Earnings per share (EPS)
Net income - preferred stock dividends / average common shares outstanding (shares outstanding at beginning of year + shares outstanding at end of year / 2) ; answer is in dollars
Working capital
current assets - current liabilities
Current ratio
current assets / current liabilities ; answer in ratio form such as 1.08:1; means that for every dollar of current liabilities, you have $1.08
Debt to total assets ratio
total liabilities / total assets ; answer in percent ; higher the ratio, the more reliant the company is on debt financing
External users
Investors (owners) use accounting information to make decisions to buy, hold, or sell stock
External user examples
creditors such as suppliers or bankers, labor unions, customers, economic planners
Internal users
managers who plan, organize, and run a business
Internal user examples
marketing managers, production supervisors, finance directors, and company officers
Financing activities
payables, common stock, dividends; borrowing money, issuing stock; it takes money to make money
investing activities
PPE, cash, investments; purchase of resources needs to operate
operating activities
revenues, expenses, liabilities/payables arising from these expenses
The ending retained earnings balance appears on
retained earnings statement and balance sheet
Which forms of business organization are considered to be separate accounting entities?
sole proprietorship, partnership, corporation
Only Certified Public Accountants may perform audits
True
Which section of the annual report presents highlights of favorable or unfavorable trends and identifies significant events and uncertainties affecting a company’s ability to pay near-term obligations, and a company’s ability to fund operations and expansion?
management discussion and analysis
clarify information presented in the financial statements as well as expand upon it where additional detail is needed.
notes to financial statements
IFRS stand for
International financial reporting standards
Which of the five elements of financial statements does the IASB’s definitional structure recognize?
assets, liabilities, equity, income, expenses
What organization issues International Financial Reporting Standards?
international accounting standard board (IASB)
Consistency means that a company uses the same accounting principles and methods as the other companies in the same industry
False
consistency means
a company uses the same accounting principles and methods from year-to-year.
A company can change to a new method of accounting if management can justify that the new method results in
more meaningful financial information
reliability
means the information is truthful and can be assumed to be correct
relevance
means the item pertains to the issue at hand
Verifiability is an ingredient of
reliability- yes relevance- no
What accounting constraint refers to the tendency of accountants to resolve uncertainty in a way least likely to overstate assets and net income?
conservatism
Under IFRS, which of the following current assets section would be presented correctly in accordance with IFRS standards?
short-term notes receivable, accounts receivable, cash
(IFRS) Under IFRS, what is the label used for common stock?
share capital
free cash flow
cash provided by operating activities adjusted for capital expenditures and dividends paid.
If cash is received in advance from a customer
liabilities will increase
Which of the following is an acceptable effect if total liabilities increase by $5,000 as a result of a transaction?
Assets increase by $5,000, or stockholders’ equity decrease by $5,000.
In its simplest form, an account consists of three parts.
true
What is the evidence that a transaction has occurred?
source document
Which is not part of the recording process?
preparing a trial balance
IFRS may differ somewhat in principles from U.S. GAAP.
true
Which of the following are not considered to be primary users of financial statements in countries outside the U.S.?
economic advisors
The most common description of IFRS as contrasted to GAAP is that:
GAAP is rules based and IFRS is principles based.
Which of the following did not result from the Sarbanes-Oxley Act?
Tax rates on corporations increased.
Top management must now certify the accuracy of financial information.
Penalties for fraudulent activity increased.
Independence of auditors increased.
sarbanes-oxley act
Which of the following became required as a result of SOX?
Top management must certify the financial statements for their company.
The payment of dividends is an example of a(n)
financing activity
A company purchased a tract of land on which it expects to build a production plant on in approximately five years. During the five years before construction, the land will be idle. In what classification should the land be reported?
long term investment
characteristics of relevance
timeliness, feedback value, predictive value, not verifiability
characteristics of reliable accounting information
verifiability, neutrality, representational faithfulness, not timliness
Which of the following are constraints that allow a company to modify generally accepted accounting principles without jeopardizing the usefulness of the financial statements?
materiality and conservatism
Which of the following differs somewhat under IFRS compared to U.S. GAAP?
the accounting equation
