GAAP Flashcards
1
Q
Conservative Principle (GAAP) - Primary Principle
A
- theme for resolving financial statement uncertainty in the least favorable way
- anticipates future losses not gains (helps you manage expectations)
- understates net assets
- requires losses be recorded as soon as they are quantified (certain or uncertain), while gains are only recorded when they are assured of being realized
If you anticipate future losses and understate the net assets it will allow companies to play it safe. if an accountant has two solutions to choose from when facing an accounting challenge, the one that yields inferior numbers should be selected
2
Q
Going-Concern Principle (GAAP) - Primary Principle
A
Financial statements are to assume that the business will last indefinitely
(No business or business owner conducts and performs on a day to day basis thinking or hoping to go out of business)
this will allow for fulfillment of financial obligations, other commitments, bank notes, or other investors you are abiding by
3
Q
Historical Cost Principle (GAAP)
A
Deals w/ assets: Assets are reported at historical costs, also known as book or true value
4
Q
Objectivity Principle - (GAAP Primary Principle)
A
- Business transactions are recorded using the best objective evidence at face value
- Don’t change numbers, don’t cook the books; document as you see it
- Prevent business from documenting slanted information and ridding documentation of bias
5
Q
Stable Monetary Unit Principle
A
Assumes Value
Assumes that money, i.e. currency stays the same each year and does not devalue.
6
Q
GAAP
A
Generally Accepted Accounting Principles
- Created by the Financial Accounting Standards Board (FASD)
- Initiates regulations to identify, measure, and communicate financial information for economic and business oriented entities, as well as parties that are actually interested in them
- Provides oversight
7
Q
FASD
A
Financial Accounting Standards Board
- Not a government entity
- Is a 3rd party governing body
- Stresses the essential characteristics of accounting in and of itself
8
Q
Balance Sheets
A
- Prepared after businesses post entries to accounts
- Ensures that the total DEBITS = total CREDITS in financial records
9
Q
Financial Statements
A
- Balance Sheets, Income Statement, Statement of Cash Flows
- Provide disclosure required by GAAP principles
- Financial Reporting
- Used by firms, investors, creditors, and authorities who provide oversight
10
Q
Standard-Setting: 4 Parties
A
- Security Exchange Commission (SEC)
- American Institute of Certified Public Accountants (AICPA)
- Financial Accounting Standards Board (FASB)
- Governmental Entities (IRS, etc.)
11
Q
Security Exchange Commission (SEC)
A
- Established at the federal governmental level and is responsible for standard setting on the federal level, but recommends that independent businesses also set their own standards w/ in a business environment
- Enforces all accounting and reporting for public companies
- “Long arm of the law” as it pertains to accounting in and of itself for publicly traded businesses
12
Q
Sarbanes-Oxley Act of 2002 (SOX)
A
- a system that auditors must choose to test and evaluate the accounting protocols within each firm, whether it is a private or public entity
- federally regulated and protocols must be adhered to
13
Q
What are the 3 components of the principles w/in GAAP?
A
- Transactions get recorded twice
- Financial statements report on a business entity only. Financial accounting deals with business operations, not with the business owner or members on a personal level. Must adhere to the financial reporting of the business alone.
- Debts, as all businesses have them, must be paid within one financial year. However, not every business cycle lasts one year. (Not everyone’s fiscal year is 365 days.)
14
Q
Matching Principle (GAAP)
A
- Any business expenses incurred must be recorded in the same period as related revenues
15
Q
What is accounting conservatism?
A
- financial reporting guidelines that require accountants to exercise a high degree of verification and utilize solutions that show the least aggressive numbers when faced with uncertainties
- intended to protect users of financial information from inflated revenues and to make sure all potential liabilities are recorded as soon as they are realized
- requires losses be recorded as soon as they are quantified (certain or uncertain), while gains are only recorded when they are assured of being realized
16
Q
What is double entry accounting?
A
- Accounting principle that requires that all transactions get recorded twice
- Equal debits and credits are made in accounts for all transactions (assets, liabilities, and equity)
- Where is money coming from, where is the money going, and why is it going there?
- Total debits always equal total credits
17
Q
What is transaction analysis?
A
- An examination where transactions are identified, recorded, and summarized.
- Comprised of 3 components; identifying, recording, and summarizing
- conducted in order to prepare financial statements and must be maintained over a period of time
- Must display increased and decreases of credits and debits
18
Q
What are the rules of debit and credit?
A
INCREASE: DECREASE
- Asset = Debit | - Asset = Credit
- Expense = Debit | - Expense = Credit
- Liability = Credit | - Liability = Debit
- Income = Credit | - Income = Debit
- Capital = Credit | - Capital = Debit
Key Notes:
- Any increases or decreases from business transactions should display where the assets, liabilities, and owner’s equity are balanced
19
Q
What is the Accounting Equation
A
- Balanced equations which are comprised to include three components: assets, liabilities, and equity
20
Q
What are assets?
A
- ECONOMIC RESOURCES business plans use in the future to MAKE MONEY. Economic resources that make money.
- Can also be cash and anything that can be turned into cash
- Examples: gold, cash, jewelry or diamonds, electronics, credit, property
21
Q
What are liabilities?
A
- Debts, often called expenses
- Normally must be paid within a year, but can be paid by using assets when current and of true value
22
Q
What is owner’s equity?
A
- Owner’s claim on total assets
- If one person owns a business, it’s his or her total claim on all the assets of the business
- However, creditors are people owners of businesses owe money to. An owner can still claim on assets and still have creditors. However, creditors may have a claim on the asset depending on the debt.
23
Q
What are the traditional examples of the Accounting Equation?
A
- Assets = Liabilities + Owner’s Equity
- Owner’s Equity = Assets - Liabilities
- Liabilities = Assets - Owner’s Equity
24
Q
What is the accounting cycle?
A
- The process of recording all accounting events the business conducts
- Begins and continues on and constantly displays when a transaction occurs (could be selling a product could be an investment, etc.) -
- also begins with with the recording of a transaction
- it is continual throughout the business operating cycle
- natural period of time occurs before certain business activities tend to repeat, normally 1 year. the cut off time will determine the period for transactions (could also be a month depending on some situations)
- 3 component process: entries, receipts, sales
- Revenues and expenses must be closed at the end of the accounting cycle
25
What is net income?
All profits earned
transferred into overall earnings
Aka "Revenue"
26
What is the correct sequence of events i the accounting cycle?
1. Transactions are recorded in a journal
2. Transactions are posted to ledgers
3. Trial balance is prepared
4. Adjusting journal entries are made
5. Adjusted trial balance is prepared
6. Financial statements are prepared
7. Closing entries are made
27
What are audits?
Evaluations that produce results based on business operations
28
What is the objective of financial statements?
1. tor provide information about overall business performance
2. also exhibit changes in financial position of a business, it's important to document this
3. they are useful for making economic decisions (especially important for owners and investors)
4. to constantly conduct a review, each and everyday, within a financial period
29
What is the income statement?
will show the results of business operations over a period of time, traditionally 1 year
30
What is the statement of owner's equity?
calculates an end of period balance of the owner's equity account
31
What are the formatting requirements of a financial statement?
1. A 3 line heading: company name, type of report (ex:balance sheet), the date and period of time
2. Place numbers in the column furthest to the right
3. to make a sub-calculation, move one column to the left
4. Draw a single line under the last number in the calculation
5. Put a double underline under the final numbers; double underline signifies end of period including the balance
32
What is activity based costing?
i
33
What are the intricate components of a financial statement?
1. inventory, product
2. specific accounts, i.e., incomes and expenses
3. cost of goods sold, based on product only (business must buy and re-sell product)
4. net income
34
What is a sole proprietor?
1. An individual, literally one person
2. No partners, not even silent partners
3. Completely un-incorporated
4. could be a small business (shoe shop w/ one person owning it)
35
How are business categorized according to accounting principles?
1. categorized primarily based on who the owners are and if they're a small business, medium to large, etc...
2. who the owners are and how many
36
What is a partnership business according to accounting principles
1. an arrangement, usually between two or slightly more parties
2. all parties agree to advance together for the mutual business operations
3. can be multiple businesses or multiple, stated individuals
37
What is a corporation according to accounting principles?
1. an artificial person
2. this artificial person creates laws within and of themselves as well (corporate law) as laws governed by the state
3. these laws govern all business that these corporate entities do
4. they'll have to declare on financial statements what types of business they are for tax purposes as well as what types of products they sell, cost of goods sold showing inventory, are they selling services
5. An artificial person which could also contain multiple businesses, multiple investors, created by the laws of the state (ex: IBM, Apple, Amazon, etc.)
38
What are the four sequential steps that all accounting systems are created to follow?
1. Analyze
2. Record
3. Adjust
4. Report
39
What are the accounts where debits reflect an increase and credits a decrease?
1. Expenses and losses
2. Assets
3. Dividends Paid
"D.E.A.D" Accounts: Debits increase expenses and losses, assets, and dividends paid
40
What are the accounts where debits reflect a decrease and credits reflect an increase?
1. Capital Stock
2. Revenues and Gains
3. Retained Earnings
4. Liabilities
"C.C.R.R.L" Accounts: Credits increase Capital Stock, Revenues and Gains, Retained Earnings, and Liabilities
41
What is income made up of?
Revenues, expenses, gains, and losses
42
What is an asset?
1. a future economic benefit that an organization either owns or controls, such as inventory, land, or equipment
43
What is a liability?
a probable future sacrifice of economic benefits arising from present obligations, a debt
44
What is revenue?
1. a measure of the financial impact on a company resulting from the sales process during a specified period of time
2. revenue is not an asset; it is a measure of the inflow or increase in the company's net assets (assets minus liabilities) generated from sales of inventory and services
3. these sales must result from the primary or central operation of the business
4. Sales resulting from non-central parts of the company's operations (ex: the disposal of a piece of land) will be reported in a different manner
5. a total of all sales made during the financial period
45
What is an expense?
1. an outflow or reduction in net assets incurred by an organization's attempt to generate revenues; includes costs such as rent expense, salary expense, and insurance expense
2. in some ways the opposite of revenue
46
What are internal controls?
1. collective redundancies added to a system to make certain that it functions properly
2. built into every system by management to help ensure that every operation is performed as intended and the resulting financial data are reliable
47
What is an accrued expense?
an expense that increases gradually over time
48
What is total asset turnover?
Indicates management's efficiency at generating sales
total asset turnover = sales revenue/average total assets
49
What is return on assets (ROA)?
Return on Assets (ROA) = Net Income/ Average Total Assets
50
What is the revenue realization principle within accrual accounting?
1. states in part that the earning process must be substantially complete before revenue can be recognized
2. Accrued revenues and the corresponding
receivables are recognized when the earning process is deemed to be substantially complete.
3. The time at which this benchmark is achieved often depends on whether a single job or a collection of independent tasks is under way. As with so many areas of financial reporting, that decision can rely heavily on professional judgment.
51
What is the outcome of the closing process?
1. The closing process moves the balance for each revenue, expense, gain, loss, and dividend paid into retained earnings
2. assets, liabilities, capital stock, and retained earnings all start out each year with a balance that is the same as the ending figure reported on the previous balance sheet
3. In contrast, revenues, expenses, gains, losses, and dividends paid all begin the first day of each year with a zero balance, ready to record the events of this new period
52
What are the 3 primary legal forms for a business?
1. proprietorship
2. partnership
3. corporation
53
What makes a corporation unique to a sole proprietorship or partnership?
1. it is a legal entity separate from its ownership (legal separation of ownership and business)
2. shareholders have no personal liability for the debts of the corporation
3. the owners of a partnership or proprietorship are personally liable for all business debts. no separation exists between the business and the ownership
3.corporations can continue in existence even after owners die or decide to switch to other investments
4. In partnerships and proprietorships, capital stock does not exist
54
What is capital stock?
when ownership of a corporation is divided into shares of stock that are issued to raise funds
Owners of capital stock are called shareholders or stockholders
55
What is the double taxation of income, as it relates to corporations?
income is taxed once when earned by the corporation and again when distributed to the owners
56
What is an expense report?
1. a separate account to document and keep track of everything that you are paying out or expensing to the business
2. must be relevant to the business
3. reflect the decreases in equity as a result of using up all assets
57
What is the cost of goods sold, as it pertains to the income statement?
A single number on the income statement
Actual cost to the business. What are they using to produce goods that they sell?
Not all businesses buy and resell goods. Some businesses sell services, so on their income statement they would not calculate the cost of goods sold.
Materials, Raw materials, resources, labor costs
58
What is the formula for cost of goods sold?
Cost of Goods Sold = Beginning Inventory + Net Purchases - Ending Inventory
**Do not understate or overstate inventory
59
What is the gross profit formula?
Sales - Cost of Goods Sold = Gross Profit (GP)
60
What is the income statement formula?
Sales - Cost of Goods Sold = Gross Profit
__________________________________________
Gross Profit = Net Income
61
What does not count toward the extraordinary gains and losses section of the income statement?
1. Business Equipment extraordinary gains and losses (can be written off as an expense)
2. Results of a lawsuit
62
What does the profitability analysis as it pertains to the income statement allow a business to know?
Allows the business to know in time how lucrative any particular existing project may be, the business itself, or different accounts or projects
Also permits an anticipation of sales potential specific to such elements like customer age (trends, and motivations of each age group), geography (urban, suburban, rural jurisdictions)
63
What are the 3 types of ways to analyze profitability?
1. Horizontal Analysis
2. Ratio Analysis
3. Vertical Analysis
64
What is horizontal analysis as it pertains to profitability analysis?
When one company compares its current results to a previous year
65
What is ratio analysis as it pertains to profitability analysis?
When a company computes a ration from various numbers on financial statements in order to analyze the results
(Ex: if interested in stocks you can compare what certain products are selling at a certain time on a certain day, perform a ratio analysis, and compare those numbers onto financial statements from another time to analyze those results)
66
What is vertical analysis as it pertains to profitability analysis?
When a company compares all the numbers on a financial statement with one key number from a separate report. (They can compare them with a number down at the bottom or on a completely separate document).
67
How is a gross profit margin useful in evaluating?
useful for evaluating profitability
68
What does a profitability analysis allow a business to do?
Forecast the lucrativeness of an existing project or the overall view of where this business financial activity will go
It also permits an anticipation of sales
69
What are the 3 elements of sales potential as it pertains to profitability analysis?
1. Age (needs and motivations)
2. Geography (3 jurisidictions: urban, suburban, rural)
3. Product Type
70
What is the gross profit margin useful for evaluating?
Profitability
Tells you about the profitability of your own goods and services
(How much profit you earn for every dollar of goods or services you generate)
71
What is the gross profit margin formula?
Gross Profit Margin = (Gross Profit / Net Sales) x 100
72
What are the 4 typical separate statements that are included in a complete set of financial statements, along with comprehensive notes?
1. Income Statement
2. Statement of Retained Earnings
3. Balance Sheet
4. Statement of Cash Flows
73
What are the main contents of an income statement?
1. a listing of all revenues earned and expenses incurred by the reporting organization during the period specified
2. gains and losses for the same period of time
74
What is a gain as it pertains to the income statement?
An increase in the net assets of an organization created by an occurrence outside its primary or central operations
75
What is a loss as it pertains to the income statement?
A decrease in net assets of an organization created by an occurrence outside its primary or central operations
76
How does a company determine whether a cost represents an asset or an expense?
A cost is identified as an asset if the benefit clearly has value in generating future revenues for the company, whereas an expense is a cost that has already helped earn revenues in the past
EXPENSE = COST THAT HELPED GENERATE REVENUES IN PAST
ASSET = COST EXPECTED TO HELP GENERATE REVENUES IN THE FUTURE
(Ex: With an asset the utility will be consumed in the year. With an expense the utility has already been consumed)
77
What is the principle of conservatism?
Whenever an accountant faces two or more equally likely possibilities, the one that makes the company look worse should be selected
(Attempts to ensure that a reporting organization never looks significantly better than it actually is)
78
When an accountant encounters a cost that is "too close to call" when trying to decide whether a cost should be reported as an asset or an expense and neither scenario appears more likely to occur, how should they report the cost?
If a cost has been incurred that might have either a future value (an asset) or a past value (an expense), the
accountant always reports the most likely possibility. That is the only appropriate way to paint a portrait of an
organization that is the fairest representation.
However, if neither scenario appears more likely to occur, the cost
is classified as an expense rather than an asset because of the principle of conservatism.
79
What does net income reflect on an income statement?
the growth in a company's net assets during the period resulting from all revenues, expenses, gains, and losses. It reflects the profitability for the period
80
What is capital stock (a.k.a. contributed capital) as it pertains to accounting financial statements?
The amount invested in the business by individuals and groups in order to become owners
This is not the same as the stock shares sold each day on the New York Stock Exchange, NASDAQ, or other stock exchanges, as those normally occur between investors and not with the company
Only the initial issuance of the ownership shares to a stockholder creates the inflow of assets reported by the company's capital stock or contributed capital account
81
What information does a retained earnings balance communicate to an outside decision maker?
Provides a measure of the profits left in a business throughout its history to create growth
Answers the question, "How much of the company's net assets have been derived from operations during its life?"
Put simply, it is the total amount of net income reported by a company since it first began operations, less all dividends paid to stockholders during that same period
82
What is the primary purpose of a balance sheet?
to report an organization's assets and liabilities at a particular point in time
Assets are listed first (usually in order of liquidity), followed by liabilities
The only financial statement that shows company's financial condition on one specific date, unlike the other financial statements that report events occurring over a period of time
83
What are current vs. noncurrent assets?
Current = Assets expected to be used or consumed within the next year)
Non-current = assets expected to remain within the company for longer than a year
84
What are current vs. noncurrent liabilities?
Current = expected to be paid during the next year
Noncurrent = not expected to be paid until after the next year
85
What is stockholder's equity made up of?
capital stock and retained earnings
86
Why does the balance sheet balance? (What are the only ways that assets can increase?)
Assets must have a source
If a business or other organization has an increase in it's total assets the change can only be caused by:
a) an increase in liabilities such as money being borrowed
b) an increase in capital stock such as additional money being contributed by stockholders
c) an increase created by operations such as a sale that generates a rise in net income
Left side of the accounting equations (assets) presents a picture of the future economic benefits that the reporting company holds. The right side provides info to show how those assets were derived (from liabilities, from investors, or from operations)
87
What does the statement of cash flows portray?
the various ways in which the company generated cash during the year and the uses that were made of it
88
What are the three categories that cash flows are divided into on statement of cash flows?
1. operating activities = relate to receipts and disbursements that arose in connection with the central activity of the organization
2. investing activities = cash flows from events that are separate from the central or daily operations of the business and involve and asset
3. financing activities = unrelated to daily business operations but the transactions relate to either a liability or a stockholders' equity balance (ex: borrowing money from a bank, distributing a dividend to shareholders, issuing stock to new owners for cash)
89
What are FOBs?
FOB = Free on Board
Documents prepared in connection with shipments made from a seller to a buyer are typically marked w/ an FOB point
FOB point indicates when legal title to property is transferred. It signifies the appropriate date for recording costs
FOB shipping point = transaction occurs when product leaves the seller
FOB destination = seller maintains legal ownership until the product arrives at its destination (the store/customer)
90
When are costs of goods sold recorded according to the perpetual inventory system?
At the time of each sale
Notes:
When each sale is made, the applicable cost is reclassified from the inventory account on the balance sheet to the cost of goods sold on the income statement
two journal entries are created at the time of transaction (sale): one for the sale and second to shift the cost of the inventory from asset to expense
91
Why are FOB points important, outside of just their importance to accounting?
1. company that holds legal title to merchandise during trip from seller to buyer normally incurs all transportation costs
Any losses or damages that occur in route affect the party holding the legal title, unless other arrangements are specified in the contract
92
When are costs of goods sold recorded according to the periodic inventory system?
Monitors the various inventory expenditures but makes no attempt to keep up with the merchandise on hand or the cost of goods sold during the year
at the time of sale, a journal entry is made to recognize the revenue of the sale. However, the cost of goods sold is neither calculated nor recorded when a sale occurs and instead is determined along with the expense for the entire period whenever financial statements are prepared
93
What are the 3 costs used to arrive at the amount reported as a company's cost of goods sold in a periodic system?
1. Beginning Inventory
2. Purchases
3. Ending Inventory
