Financial Accounting 4-5 Flashcards
What are explicit transactions?
Transactions triggered by a specific event, often an exchange of resources between two parties.
What are implicit transactions?
Transactions that do not have a specific trigger and often involve judgment in determining timing and amount of journal entries.
What are adjusting entries?
Journal entries made at the end of an accounting period to record necessary adjustments.
What principles do adjusting entries aim to conform to?
- Revenue recognition
- Matching principle
What are accruals?
Transactions where cash changes hands after revenue or expense is recognized.
What are deferrals?
Transactions where cash changes hands before revenue or expense is recorded.
What is the purpose of accruals and deferrals?
To accurately reflect revenues or expenses at the end of the accounting period.
What is the perpetual inventory system?
A system that records the expense for inventory at the time it is sold.
E.g. when item scanned and purchased, accounting system automatically records the journal entry transferring the inventory item from inventory to COGS
What is the periodic inventory system?
A company records Cost of Goods Sold periodically, e.g. at the end of each month, after an inventory count reveals inventory on hand
What are the main inventory costing methods?
- First In First Out (FIFO)
- Last In First Out (LIFO)
- Weighted average
- Specific identification
What are product costs?
Costs incurred to buy, manufacture, and deliver a good or service to a customer.
What are period costs?
All other costs a company incurs while doing business, such as executive salaries or office rent.
What are the three stages of inventory for a manufacturing business?
- Raw materials
- Work in process (WIP)
- Finished goods
Fill in the blank: Implicit transactions often lead to _______ entries.
adjusting
True or False: Accruals and deferrals are unrelated to revenue recognition.
False
What is the goal of adjusting journal entries?
To accurately reflect the activities related to an accounting period.
What must a business determine when making a purchase?
The corresponding benefit that will come from that purchase.
What is depreciation expense related to?
Long-lived physical assets, such as machinery and buildings, over multiple periods.
How is straight-line depreciation calculated?
By dividing the gross book value by the estimated useful life of the asset.
What should be subtracted from the gross book value before calculating depreciation?
Any salvage value.
What is the net book value of an asset?
The original cost of the asset, minus accumulated depreciation.
Why is land not depreciated?
It is not ‘used up’ by the business and its value is typically not reduced or consumed.
What is an example of an accelerated depreciation method?
The double declining balance method.
How does the choice of depreciation method impact net income?
It can cause lower net income in the early years and higher in the later years for accelerated methods.
What happens when an asset is sold?
The journal entry eliminates net book value and recognizes any gain or loss based on the sale price.
How are intangible assets treated in accounting?
They are amortized rather than depreciated.
What is the allowance for credit losses?
A contra-asset account used to recognize potential credit risks.
What does the allowance for credit losses record?
The estimated amount of receivables considered uncollectible.
How is the bad debt expense account used?
To record any increase to the allowance for credit losses.
What happens when specific receivables fall past due?
They are written off from the balance sheet.
What are deferred tax assets and deferred tax liabilities?
They arise because temporary timing differences can cause the calculation of taxable income to differ from how a business calculates its income before taxes for financial reporting purposes.
What is a deferred tax liability?
A deferred tax liability arises when there is an amount of tax that is going to be due in the future, related to income that is reported in the current period. It arises when taxable income is less than income before taxes
What is a deferred tax asset?
A deferred tax asset reflects a prepayment of some amount of tax on an amount that has not yet been reported as income on the income statement. It arises when taxable income exceeds income before taxes.
What role do adjusting journal entries play in the closing process?
Adjusting journal entries are part of the closing process, which is an opportunity for a company to evaluate its trial balance and ensure that proper accruals and other adjusting entries have been made.
What is the purpose of the closing process?
The closing process ensures that the financial statements will accurately reflect the results of all transactions that occurred during the period.
What is the statement of cash flows?
The statement of cash flows is the third and final financial statement, alongside the balance sheet and income statement.
What is the purpose of the statement of cash flows?
The purpose is to provide a detailed picture of what happened to a business’ cash during an accounting period, showing cash used or received and reconciling beginning and ending cash balances.
Why are cash flows important?
Cash flows are important for valuing a business and managing liquidity, helping to understand where actual cash is generated and used.
What are the sections of a statement of cash flows?
The sections are Operating Activities, Investing Activities, and Financing Activities.
How does the format of the statement of cash flows differ?
The format differs slightly between US GAAP and IFRS.
What does the Cash Flows from Operating Activities section include?
It includes information on cash used or received in preparing and providing goods or services to customers.
How is the Cash Flows from Operating Activities section related to net income?
It shows what net income would be under the cash accounting method by removing components of the income statement that do not impact cash.
What are the two methods for preparing the operating section?
The two methods are the direct method and the indirect method.
What is the direct method for calculating cash flows from operating activities?
The direct method involves taking all cash collections from operating activities and subtracting all cash disbursements.
How does the indirect method differ from the direct method?
The indirect method starts with net income and makes adjustments to undo the impact of accruals made during the period.
What does the Cash Flows from Investing Activities section contain?
It contains cash flows relating to long-lived assets, such as property, plant, and equipment, and includes loans receivable and certain investment securities.
What does the Cash Flows from Financing Activities include?
It includes cash flows associated with raising and paying back money to investors and creditors.
How are dividends treated under US GAAP and IFRS?
Under US GAAP, dividends paid are included in the financing section. Under IFRS, they may be included in the operating section.
How is interest paid categorized under US GAAP and IFRS?
Under US GAAP, interest paid is included in the operating section. Under IFRS, it can sometimes be included in the financing section.
What is a useful way to assess a business’s cash management?
Creating a statement of sources and uses of funds.
Why is context important when interpreting the statement of cash flows?
The phase of the business (e.g., startup, profitable/growing, mature, or declining) affects expectations for its cash flow statement.
What cash flow characteristics are typical for a startup?
Typically has negative or very low cash flow from operating activities, negative cash flow from investing activities, and large fluctuations in cash flow from financing activities.
What cash flow characteristics are typical for a profitable/growing business?
Usually has positive cash flow from operating activities, negative cash flow from investing activities, and positive, negative, or neutral cash flow from financing activities.
What cash flow characteristics are typical for a mature company?
Generally has positive cash flow from operating activities, slightly negative cash flow from investing activities, and negative cash flow from financing activities.
What cash flow characteristics are typical for a business in decline?
Typically has negative cash flow from operating activities, positive cash flow from investing activities, and cash flow from financing activities that could be either positive or negative.
What is the revenue recognition principle?
Revenue(s) should be recorded when (or as) an organisation satisfies its performance obligations. This process requires companies to identify all the performance obligations in each customer contract and allocate the transaction price to each performance obligation. When revenue is recognised, it increases owner’s equity.
What is the Matching Principle?
A principle behind Accrual Accounting which states that expenses should be recognised in the same period in which the related revenue is recognised rather than when the related cash is paid
How are gains and losses recognised?
Losses: debit
Gain: credit
What is a contra asset account
An asset account with a credit balance, that’s the opposite of normal debit balance
Do expenses increase with a debit or a credit?
Expenses increase with a DEBIT
*Because expenses decrease equity, and equity normally increases with a Credit
