Financial Accounting Ch 2

Question 1

what are the 2 characteristics an asset must possess?

Answer 1

1. it must be owned or controlled by the company

2. it must possess probable future benefits that can be measured in monetary units

Question 2

define current asset.

what accounts make up current assets?

Answer 2

Assets used up or converted into cash within one year:

• Cash
• accounts receivable
• inventory
• other current assets

Question 3

define non-current asset.

what accounts make up non- current assets?

Answer 3

Assets not used up or converted to cash in one year:

• PPE
• goodwill
• intangible assets
• Equity method investments
• other non current assets

Question 4

define current liabilities.

what accounts make up current liabilities?

Answer 4

Liabilities requiring payment within one year:

• Short term borrowings
• trade accounts payable
• accrued expenses
• income taxes

Question 5

define non current liabilities.

what accounts make up non current liabilites?

Answer 5

Liabilities not requiring payment within one year:

• Long term debt
• deferred income taxes
• other
• Shareholders Equity ( common stock, paid in capital, retained earnings)

Question 6

define historical cost

Answer 6

refers to original acquisition costs.

Physical tangible assets that are intended to be used (inventory, PPE) are reported as historical cost

Question 7

What are some examples of current liabilities?

Answer 7

Accounts payable, accrued liabilities and short term borrowings

Question 8

define accrual accounting (GAAP)

Answer 8

accounting method where revenue or expenses are recorded when a transaction occurs rather than when payment is received or made

Question 9

what are the 5 categories of account titles?

Answer 9

Assets, liabilities, equity, expenses, Revenue and income

Question 10

What is income and how is it measured?

Answer 10

The profit or loss determined by taking all revenues and subtracting all expenses from both operating and non-operating activities.

Question 11

Describe Revenue impact on income measurement

Answer 11

• Primary source of income
• referred to as the “top line”
• revenues increase net income
• recorded when company sells goods or service

Question 12

Describe expenses impact on income measurement

Answer 12

• expenses decrease net income

* Decreases in stockholders equity due to delivery of good and services to customers, cost of doing business

Question 13

What is the net income equation?

Answer 13

Net income = [revenues – expenses] + [gains – losses]

Question 14

what is a permanent account?

Answer 14

• also known as stock accounts
• accumulate all changes to date
• Assets, liabilities, equity

Question 15

What is a temporary account?

Answer 15

• also known as flow accounts
• Closed at each period
• income statements revenues, expenses, gains and losses

Question 16

Why is the income statement/income useful?

Answer 16

Measures performance and shows firms weatlth and how its changed.

summarizes sales and expenses in one period in order to measure the profit of a company in one period

Question 17

How do you calculate Ending retained earnings?

Answer 17

RE end = Beginning RE +-(net income/loss) - Dividends

Question 18

What accounts link the balance sheet and the income statement?

Answer 18

Net income and retained earnings

Question 19

What are the advantages of Accrual Basis accounting?

Answer 19

Accrual recognized transaction in the time period when revenue and expenses occur not necessarily when cash changes hands.

Costs are matched to revenues providing a better measure of performance in a period.

Question 20

In a cash sale when is revenue recognized?

Answer 20

At the point of sale - the company has fulfilled its responsibilities in the exchange with the customer

Question 21

In a credit sale, when is revenue recognized?

Answer 21

Under GAAP, revenues are reported when a company has earned those sales at delivery. Earned means that the company has done everything required under the sales agreement—no material contingencies remain

Question 22

what is the matching principle?

Answer 22

record expenses in the same period that associated revenues recognized or in period of benefit.

Question 23

What is the “bottom line”

Answer 23

Bottom line is the net income (earnings) for the period

Question 24

What is the “top line”

Answer 24

Top line are Gross sales/profit of a company

Question 25

What is EPS and how is it calculated?

Answer 25

Earnings per share = net income / Average number of common shares outstanding

Question 26

Why is EPS important?

Answer 26

They drive stock prices

Higher EPS = higher stock prices and visa versa

Question 27

What is ROE and how is it calculated?

Answer 27

Return on Equity = Net income / average stockholders equity

ROE is the key measure of profitability.
measures the amount of profit earned for each dollar invested by stockholders

Question 28

What is debt to equity ratio what does it measure and how is it calculated?

Answer 28

Debt to equity ratio = total liabilities / total stockholders equity

Key measure of financial leverage and long term solvency

measures proportion of financing from creditors to financing from owners ( High values indicate that the company relies heavily on funds provided by creditors)

Question 29

what happens with debits and credits on the balance sheet in the accounting equation Form? ( pertaining to T-accounts)

Answer 29

Assests ( debit side increases, Credit decreases )

Liabilities ( Debit side decreases , credit side increases)

Equity ( Debit side decreases, credit side increases)