Financial Accounting Flashcards
GAAP
Generally Accepted Accounting Principles.
!= tax accounting
FASB
Financial Accounting Standards Board
IFRS
International Financial Reporting Standards
Separate Entity Assumption
Assume we treat business and owner are separate entities. Focus on accounting for business not the owners
Unit of Measure Assumption
Assume the currency with which the company is operating
Going Concern Assumption
Assume the company will continue to operate
Periodicity Assumption
Assume we can pick any time period and report that time period’s financial results
Materiality
Assume that only useful financial information will be disclosed in financial statements for those that make decisions based on that information
6 Qualities of Accounting
- Understandability
- Timeliness
- Full Disclosure
- Comparability
- Objectivity
- Decision Relevance
Balance Sheet
Summarizes, as of a specific date, the
- assets owned by the company
- liabilities owed by the company to its suppliers and to lenders who have provided funds for the business
- the accumulated funds the owners of the enterprise have invested and left with the business to cover its operating needs
The Accounting Equation
Resources of the firm equal the creditor’s and owner’s claim to those resources.
Assets = Liabilities + Owners Equity
Assets
Tangible or intangible resources that can be measured in dollars which are owned by the company and can be expected to provide future economic benefits to the company.
Always equal to the sum of liabilities + owners equity
Liabilities
The dollar measure of the company’s obligations to repay monies loaned to it, to pay for goods or services it has received, or to fulfill commitments it has made.
5 Common Asset Accounts
- Cash
- Accounts Receivable & Notes Receivable
- Inventory
- Buildings & Equipment
- Copyrights & Patents
(Listed in order of liquidity)
Cost Principle
Assets are valued at their historic cost
Owners Equity
The dollar measure of the owners’ investment in the company.
Residual interest of owners to assets
OE = A - L
5 Common Liability Accounts
- Accounts Payable
- Notes Payable
- Interest Payable
- Accrued Salaries
- Deferred (unearned) Revenues
Required Financial Statements
- Balance Sheet
- Income Statement
- Statement of Cash Flows
- Statement of Owners Equity
Income Statement
Summarizes the transactions that produced revenue for the business as a result of selling its products or services during a specific time period.
The difference between aggregate revenue and aggregate expenses during a specific time period is the ‘net income (or loss)’ the business earned. Aka the profit or “bottom line”.
Accrual Basis Accounting
Revenues are recognized when earned rather than when the cash is collected.
Expenses are recognized when the goods or services are received.
Which of the following does NOT represent a cash outflow from the firm?
- Depreciation
- Taxes
- Interest Payments
- Dividends
- Salaries
Depreciation does not represent a cash outflow from the firm.
Statement of Cash Flows
Summarizes the sources of the company’s cash funds during the period and the uses the company made of those funds.
types of major activities: \+/- Operating Activities \+/- Investing Activities \+/- Financing Activities = Change in Cash
Operating Activities
Major operating cash inflow - cash receipts from selling goods or providing services
Major operating cash outflow - cash to purchases inventories or to pay operating expenses (rent, utilities, salaries, etc.)
Direct Costs vs Indirect Costs
Direct includes explicitly stating from and where cash comes and goes
Indirect starts with net income and adds adjustments to get ‘cash flow from operating activities’.
Indirect method is not permitted in IFRS but is the common practice in GAAP.
Investing Activities
Buying and selling long-term assets (land, building, equipment).
Financing Activities
Cash obtained from or repaid to owners or creditors (loans, repayments, stock issuance).
Unqualified Opinion
Equivalent to ‘clean opinion’
Modified Opinion
Means the auditor to exception to something they found
Adverse Opinion
Auditor findings are not within GAAP rules
Financial Position
Balance Sheet
CPA is not responsible for
the financial statements (the accuracy)
PCAOB
Public Company Accounting Oversight Board
Matching Principle
Governs expense recognition.
Costs are reported as expenses in the same time period as their related revenues.
finish this statement
Costs that cannot be matched with specific revenues are matched with…
future time periods that benefit from the cost
Capital Stock
What the company received when selling shares of its stock
Retained Earnings
Accumulated earnings less dividends
aka Retained Earnings = Accumulated Earnings - Dividends
Dividends
A distribution of earnings that occurs when a board of directors decides to distribute earnings.
Statement of Retained Earnings
Shows how retained earnings changes in a given period of time.
Beginning Retained Earnings
+ Net Income
- Dividends
= Ending Retained Earnings
“Current” assets will be handled within what timeframe?
1 year
“Long Term” assets will be handled within what timeframe?
More than 1 year
Where are cash dividends reported?
On the Statement of cash flows and ‘Cash flows from financing activities’.
Statement of Owners Equity
Summarizes the major transactions during a specific period that affected the owners’ interest in the company. Including the net income the enterprise earned and the amount of those earnings that owners elected to distribute to themselves.
Goodwill
Represents the difference between the purchase price and the fair market value (fmv) of an acquired asset at the time of purchase. If price is higher than fmv, then goodwill is positive. If price is lower than fmv, then goodwill is negative.
Current Ratio
Current Assets / Current Liabilities
A high current ratio is said to be ‘liquid’
A low current ratio is ‘illiquid’
Complete this statement
The flow of revenues depends on the seller’s completion of a … and does not depend on …
sales agreement and does not depend on the flow of cash.
Choose one
A balance sheet shows:
- Dividends distributed to stockholders
- Operating expenses for the period
- Earnings per share for the period
- Claims owners have against the assets of the firm
- Sales revenue
Claims owners have against the assets of the firm
T/F
A clean financial statement audit opinion still state that the financial statements are guaranteed to be accurate.
False
The form of business organization that is legally separate from its owners is a
- corporation
- partnership
- limited partnership
- proprietorship
- none of the above
Corporation
Which of the following would not be a liability on a Balance Sheet?
- depreciation
- deferred revenue
- accounts payable
- wages payable
- dividends payable
Depreciation
Which one of the following is NOT an example of a current asset?
- intangible assets
- pre-paid expenses
- cash
- marketable securities
- accounts receivable
Intangible assets
Which of the following is not included as an expense on the income statement?
- dividend expense
- marketing expenses
- cost of goods sold
- depreciation expense
- bad debt expense
Dividend expense
A firm reports the following income statements for FY2020: Sales of $60,550,000 Income tax of: $1,744,000 Operating expenses: $10,115,000 Cost of goods sold: $34,025,000 Interest expense: $750,000
The firm also declared and paid $947,250 in dividends in FY2020
What is the amount of the firms Net Income Before Interest and Taxes?
$16,410,000
Which of the following does NOT represent a cash outflow from the firm?
- depreciation
- taxes
- interest payments
- dividends
- salaries
Depreciation
T/F
A firms balance sheet provides representation of the current market value for the company.
False
A balance sheet dated December 31, 2018 represents the financial position of the firm:
- from Jan 1 2018 to Dec 31 2018
- only for December 31, 2018
- from the time the firm began business to Dec 31, 2018
- none of the above
Only for Dec 31, 2018
Which statement describes the accounting equation?
- Resources of the firm equal the creditors and owners claim to those resources
- the change in retained earnings equals net income less dividends
- revenue and expense transactions must equal over time
- financing activities equal investing and operating activities
- assets equal liabilities minus owners equity
Resources of the firm equal the creditors and owners claim to those resources
In accrual basis accounting
- revenues are recognized when earned rather than when cash is collected
- expenses are recognized when paid rather than when incurred
- frequently revenue are earned or recognized when merchandise is acquired to resale by paying the cost
- cash collected less cash distributed equals net income
- none of the above are correct
Revenues are recognized when earned rather than when cash is collected
T/F
The income statement represents a snapshot of the firms account balances at a point in time.
False
If bonds are issued at a premium, the stated interest rate is:
- higher than the market rate of interest
- lower than the market rate of interest
- too low to attract investors
- adjusted to a higher rate of interest
- zero
Higher than the market rate of interest
Which of the following is a contra-asset account?
- paid in capital in excess of par
- bonds payable
- income taxes expense
- copyrights
- treasury stock
- accumulated depreciation
- pre-paid expenses
Accumulated depreciation
Financial statements must be consolidated if:
- a company uses the equity method of accounting
- a company owns more than 20% of another company
- a company owns more than 50% of another company
- mark to market accounting is used
- a company owns between 20% and 50% of another company
A company owns more than 50% of another company
Which of the following pairs of accounts are usually current liabilities?
- income taxes payable, unearned revenue
- accounts payable, accounts receivable
- prepaid expenses, wages payable
- additional paid in capital, deferred tax liability
- notes receivable, bonds payable
Income taxes payable, unearned revenue
Which of the following are intangible assets?
- accounts receivable and notes receivable
- equipment and tools
- office supplies and accounts receivable
- patents and goodwill
- land and equipment
Patents and goodwill
Ending retained earnings formula
Ending retained earnings =
beginning retained earnings
+ net income
- dividends declared
Define Cash
Anything a bank will accept for deposit: checks, money orders, bank credit card slips.
Cash equivalents
Investments that the company that come due within 3 months
What is Bad debt expense for?
For receivables that won’t be collected. And is recorded on the income statement as it doesn’t carry over year to year.
What is ‘Allowance for bad debts’ for?
A balance sheet contra-asset account that accounts for bad debt expenses.
EOY amount carries over to next year as beginning balance.
example question for bad debt expense
A sale occurs to a client in 2019 that includes delivery in 2020. Client goes bankrupt in 2020 and debt cannot be collected.
What year is the bad debt expense recognized in and why?
Per the revenue recognition principal, the bad debt expense must be recognized in 2019.
What are the 2 methods of estimating bad debt expense/allowance for bad debts and how are they calculated?
- Percentage of Credit Sales Method (% x Credit Sales)
2. Percentage of Receivables Method (New Allowance for Bad Debts - Previous Allowance for Bad Debts)
Define New Allowance for Bad Debts
Percentage(s) of ending balance in A/R
E.g. debts that will be repaid in different time frames have different chances of being collected:
<30 days: 62k x 1% = $620
31-60 days: 15k x 3% = $450
61-90 days: 20k x 7% = $1400
Total = $2,470 is New Allowance for Bad Debts
Define Notes Receivable
Formal contracts signed when a customer buys merchandise or services on credit. Include due dates, interest payment amounts, and the interest rates.
What’s the difference between current and long term Notes Receivable (assets)?
Current are due within 1 year
Long term are due beyond 1 year
Define Principal
The face amount of the note (aka amount borrowed)
Define Interest Rate
A percentage of the principal the maker is charged to borrow money.
Define Maturity Value
Sum of Principle + Interest
What is the calculation for Interest Amount
Principal x Interest Rate x Time
E.g. Company sells equipment on Jan 1, 2020 and received a 90-day, $5k note at 14% interest rate the interest amount would be:
$5k x 0.14 x 90/365 = $172.60
Define Discounting Notes Receivable with Recourse
Selling a Receivable so as to receive the cash early or to not be bothered with the effort to collect.
T/F
Discounting Notes Receivable is a liability on the balance sheet
False.
This isn’t technically a liability but it should be disclosed on the financial statements
Discounting Notes Receivable appears on the balance sheet. What is another name for this?
Factoring Accounts Receivable
What are the 4 types of Cost Flows used to manage inventory?
- Specific Identification
- FIFO
- LIFO
- Weighted Average
Define Weighted Average Cost method for estimating COGS
Involves an average cost of all purchases made, weighted by the respective number of units
E.g selling 20 tons of widgets at end of year
10 of which cost $6 per ton bought early in the year
10 of which cost $9 per ton bought later in the yesr
Average cost = ($6+$9)/2 = $7.5
Weighted Average Cost = $7.5 * 20 = $150
Define Inventory
Goods that are manufactured or purchased for resale
Who ‘owns’ Goods In Transition? Whose balance sheet does it appear on?
Whoever pays for the shipping records the inventory on it’s balance sheet.
Define Goods on Consignment
A company gives goods to another company on Consignment telling them that they can sell the goods and keep a percentage of the sale. If they don’t sell, then they can return the merchandise to the loaner.
Does title transfer on consignment of goods?
No, with consignment the value stays on the owning entities balance sheet not the seller.
What is the formula for Cost of Goods Sold (COGS)?
Beginning Inventory
+ Net Purchases
- Ending Inventory
= COGS
What is the formula for Net Purchases?
Purchases \+ Freight-In - Purchase Returns & Allowances - Purchase Discounts = Net Purchases
What is the formula for Gross Margin?
Sales
- COGS
= Gross Margin
What are the 2 ways Gross Margin is reported and what’s the difference?
- Gross Method
- Net Method
Gross Method is calculated from:
Sales Revenue
- COGS
= Gross Margin
Net Method does not take into account COGS and just reports the Net as the Sales Revenue
Why would a company want to use Gross Method to calculate Gross Margin which appears on the Income Statement?
To inflate sales revenue.
Note: brokers between buyers and sellers are not permitted to use Gross Method. Must use Net Method.
Define Perpetual Inventory System
Updated when a purchase or sale is made. Used when inventory items often have high value.
Define Periodic Inventory System
Records NOT updated whenever a purchase or sale is made. Used when inventory is large, diverse, and made up of items with low value.
Usually done once a year and is referred to as ‘physical inventory count’
Define Inventory Shrinkage and Inventory Swell
Shrinkage = inventory loss Swell = Inventory increase
What is the Lower Cost or Net Realizable Value (NRV) Rule?
Inventories are reported at the lower of the cost amount or the net realizable value.
What is the LIFO conformity Rule?
If a company uses LIFO for income tax purposes it must also use LIFO for financial reporting purposes.
Define pre-paid expense
Pre-paid expenses are expenses paid for up front that have respective benefits received later.
recorded as a CONTRA-asset (current).
Define Marketable Securities
Short term investments in stocks or bonds which are reported at market value per the ‘Mark to Market’ rule.
EXCEPTION: Bonds are reported at cost if intent is to hold bond to maturity.
What is the Mark to Market Rule?
Marketable securities (stocks and bonds) are reported at Market Value and not at historical cost.
If a company owns >50% of a companies stock then the owning company must ….
consolidate financial statements.
If a company owns between 20% and 50% of a company’s stock then they owning company must…
use the ‘Equity Method’ of accounting which requires dividend revenue be recognized as the owned company earns the respective revenue.
If a company owns < 20% of a company’s stock then they must…
report per the ‘Mark to Market’ rule and report market value.
What are examples of Fixed (Tangible) Assets and how do they allocate cost of an asset over period benefited?
- Land (Does not depreciate)
- Buildings, Equipment, and Land Improvements (Depreciation)
- Natural Resources (Depletion)
What are examples of Intangible Assets and how do they allocate cost of an asset over period benefited?
- Patents (20 years) & Copyrights (50 years after death of author) amortize over the minimum of legal life or economic life
- Trademarks do not amortize and are indefinite, so long as they are not impaired.
What are examples of purchased asset costs?
Costs incurred to prepare an asset for initial use:
- Freight Cost
- Installation Cost
- Testing Costs
What are examples of constructed asset costs?
Costs incurred to build and ready an asset for initial use:
- Materials
- Construction labor
- Share of general company overhead
- Capitalized interest
What is capitalized interest?
Capitalized interest is treating interest paid as an asset rather than as an expesne. Capitalized interest does not appear on the income statement.
What are ‘ordinary expenditures’?
Ordinary expenditures are expenditures on existing assets that only benefit the period in which they are made.
These appear on Income Statement as expenses
Examples:
- Repairs
- Maintenance
- Minor Improvements
What are ‘capitalized expenditures’?
Capitalized Expenditures are expenditures on existing assets that benefit over several periods, not just the current period and either:
a) extend lifetime of asset
b) add capacity
These expenditures appear on the Balance Sheet as capital expenditures.
What is Straight Line Depreciation Formula?
(Cost - Salvage Value) / Useful Life = Annual Amount
What are the 4 common depreciation methods?
- Straight Line
- Units of Output
- Accelerated Depreciation - Sum of Years
- Accelerated Depreciation - Double Declining Balance
How is depreciation presented on a balance sheet?
Equipment - Accumulated Depreciation (A contra-asset) = Equipment (Net)
How are gains or losses on a disposed asset calculated?
Proceeds - Book Value = Gain or Loss
How is depletion of a natural resource calculated?
Similar to ‘unit of output method’ - more volume, more depletion.
How are indefinite assets evaluated if they do not depreciate or amortize?
If indefinite, intangible assets are tested for impairment every year.
If book value > future cash flows, then the asset is impaired.
How is goodwill calculated?
Purchase Price - FMV of Net Assets
T/F
All R&D Costs are expensed immediately and are not capitalized
FALSE
Software development costs are can be capitalized once technology feasibility is determined and can occur till the software is GA.
Define Current Liabilities and provide a few examples
Current Liabilities are debts or obligations that are due within 1 year.
Examples include:
- Accounts Payable
- Wages Payable
- Income Tax Payable
- Accrued Interest
- Unearned Revenue (e.g. restaurant gift cards)
What is formula for ‘Working Capital’
Current Assets - Current Liabilities
What are contingent liabilities?
Contingent liabilities are potential liabilities that might occur.
- If probable & amount can be reasonably estimated
- If ‘reasonably possible’ OR amount cannot be reasonably estimated.
- Remote
Define ‘Long Term Liabilities’ and provide examples
Debts and Obligations NOT due within 1 year.
Examples include:
- Notes payable
- Mortgages payable
- Lease obligations
- Deferred taxes
- Bonds payable
- Pension obligations
Long term liabilities are recorded at their _____ values which are derived from discounting _____ amounts
Long term liabilities are recorded at their present values which are derived from discounting future amounts
Define Operating Lease
A type of lease obligation that is short term and is recorded on income statement as an expense.
Define Capital Lease
A type of lease obligation that is long term (1+ years). Recorded on the balance sheet as both an asset and a liability at ‘present value of future payments’
Define Deferred Taxes
Taxes that are owed later due to a difference in timing and the use of taxable income on the income statement and taxable income for the IRS.
What are Bonds Payable and why would a company use them?
Instruments sold to the public, and can then be publicly traded, in order to raise funds for the business. Bonds bring in money without diluting ownership.
If a bond is redeemed by a bond-holder, what must the company pay?
The company must repay the principle amount of the bond.
Define ‘face value’ of a Bond
The amount to pay when the bond matures.
What is the difference between a bond premium and a bond discount?
Premium = stated interest rate > market interest rate Discount = stated interest rate < market interest rate
Bonds pay interest based on the stated rate on a regular basis (once or twice a year).
Define debentures
unsecured bonds
Define ‘carrying value’ of a bond
Bonds Payable (- or +) Discount or Premium = Carrying Value
When a bond is called in early it is referred to as _____
early retirement
Early retirement can generate a gain or loss. What is the formula for the gain or loss?
Cash Paid - Carrying Value = Gain or Loss
T/F
Bonds reduce net income while stocks dilute ownership
TRUE
T/F
Stockholders Equity includes Treasury Stock as a positive value
FALSE
Treasury Stock is a CONTRA-Equity and should be subtracted from Stockholders Equity: Retained Earnings \+Preferred Stock \+Common Stock \+Paid in Capital Above Par Value - Treasury Stock
of authorized shares =
shares issued (sold) + # shares unissued
shares issued =
shares outstanding + # of treasury shares
Earnings Per Share =
Net Income / # of Shares Outstanding
What is the date of declaration?
The date the board of directors votes to pay dividends. On this date, the dividend payment becomes a liability on the balance sheet.
What is the date of record?
The date on which ‘who receives dividends’ is determined.
What is the date of payment?
The date dividends are actually paid out as cash.
What is dividend preference formula?
of shares x % value x par value = dividend preference
What preferences do preferred shares get?
Get paid dividends first (per current dividend preference) but only up to promised amount.
Get paid dividends in arrears if available.
Common stockholders get remainder.
Define stock dividends
Stock dividends are distributions of additional stock in proportion to current holdings.
T/F
Stock dividends have no effect on total stockholders equity.
True
Stock splits do what to the par value per share?
Decrease par value per share
Define Non-Controlling Interest and where it is used
Non-controlling interests are the portion of owners equity not controlled by the parent company.
Reported in Stockholders Equity section of liabilities section of CONSOLIDATED balance sheet.
T/F
Stock-based compensation must be reported as an expense on the income statement.
FALSE
Recently, this was changed. Startups paying employees with large stock grants didn’t like it as it exposed comp within companies.
