Financial Accounting 1-3 Flashcards
What is the Accounting Equation?
Assets = Liabilities + Owners Equity
The Accounting Equation is fundamental to understanding accounting principles.
What happens to the accounting equation when transactions occur?
It must always balance, reflecting increases or decreases in assets, liabilities, and/or owners’ equity.
Define a transaction in accounting.
An event that occurs during the course of starting or running a business.
Give examples of transactions.
- Making an equity investment
- Taking a loan
- Purchasing inventory
- Selling goods
- Performing services
- Ordering office supplies
What accounting method do most companies use?
Accrual method of accounting.
What does the accrual method of accounting entail?
Transactions are recorded in the period they relate to, regardless of cash exchange timing.
List some guiding principles of accounting.
- Conservatism
- Relevance vs. reliability
- Historical cost
- Consistency
- Materiality
- Entity concept
- Money measurement
- Going concern
Define assets in accounting.
Resources owned or controlled by an entity that will produce benefits in the future.
What are liabilities?
Obligations to pay a third party for resources provided to an entity.
What constitutes owners’ equity?
Funds contributed by owners as well as profits generated by the business.
Define revenue in accounting.
The money that a business receives from providing goods or services to a customer.
What are expenses?
The costs associated with providing goods or services to a customer.
Fill in the blank: Assets are resources owned or controlled by an entity that will produce _______.
[benefits in the future]
True or False: The accounting equation can become unbalanced.
False
What are the smaller groupings called that businesses use to record transactions?
Accounts
Examples of accounts include cash, accounts receivable, inventory, and fixed assets.
What accounting method is used for recording transactions?
Double entry accounting
This method uses debits on the left and credits on the right.
In double entry accounting, what do debits and credits represent?
Increases or decreases
The meaning of debits and credits depends on the account being debited or credited.
Which accounts increase with a debit and decrease with a credit?
Assets and expenses
Conversely, liabilities, equity, and revenue increase with a credit and decrease with a debit.
Fill in the blank: Assets and expenses increase with a ______ and decrease with a credit.
Debit
Fill in the blank: Liabilities, equity, and revenue increase with a ______ and decrease with a debit.
Credit
What is the first step in the recording process?
Identify transaction
What is the second step in the recording process?
Understand transaction
What is the third step in the recording process?
Create journal entry
What is created after posting to T-Accounts?
Trial balance
What do businesses create after preparing the trial balance?
Financial statements
What are the two types of accounts found in the trial balance?
Real accounts and nominal accounts
Real accounts reflect cumulative balances and appear on the balance sheet, while nominal accounts represent activity over a period and appear on the income statement.
What types of accounts are classified as real accounts?
Assets, liabilities, and equity accounts
Real accounts appear on the balance sheet.
What types of accounts are classified as nominal accounts?
Revenues and expenses
Nominal accounts appear on the income statement.
What happens to the balances of nominal accounts at the end of each accounting period?
They are transferred to retained earnings
This allows nominal accounts to start back at zero for each new accounting period.
What does the balance sheet show?
A company’s financial position as of a specific date
It provides a snapshot of the business at a specific point in time.
Under US GAAP, in what order are accounts presented on the balance sheet?
Current assets, non-current assets, current liabilities, non-current liabilities, and owners’ equity
Items within each group are presented in order of liquidity.
Under IFRS, how are accounts typically presented on the balance sheet?
Non-current assets, current assets, owners’ equity, non-current liabilities, and current liabilities
This order presents the least liquid items first.
What does the income statement show?
A company’s financial performance over a period of time
It includes all revenue and expense accounts for a specified duration.
What is gross profit?
Sales less cost of goods sold
It is one of the measures of income shown on the income statement.
What is operating income?
Gross profit less operating expenses. Also known as EBIT.
It is another measure of income that reflects the company’s profit from operations.
What is the formula for net income?
Income before taxes less taxes
Net income is the final measure of profit shown on the income statement.
What two important financial statements are discussed in the module?
Balance sheet and income statement
These statements show the company’s financial position and performance, respectively.
What is the significance of the statement of cash flows?
It is the third and final financial statement
Further details will be covered in Module 5.
Fill in the blank: The balance sheet shows all of the ______, liabilities, and owners’ equity accounts as of a specific date.
asset accounts
True or False: The income statement can only show net income.
False
The income statement can show various measures of income, including gross profit and operating income.
How do you calculate Operating Income?
Gross profit (net sales - COGS) - operating expenses.
You do NOT subtract interest or tax expenses
What is another term for EBIT?
Operating Income
What is Net Income
Total Revenue - (Expenses + Taxes)
Name ways to calculate Operating Income
How is depreciation classed on the income statement?
As an operating expense
