HBX- Accounting 1 Flashcards
To study for the HBX final exam
What is the main accounting equation?
Assets = Liabilities + Owners’ Equity
What is Owner’s Equity?
Owners’ Equity = Assets – Liabilities Contributions made by the owner (This is more flexible! Payments are discretionary not obligatory. Also- owners make decisions!) Essentially, owners’ equity is the difference between what a business has and what a business owes to others. The amount that would be left over after a business settles all its obligations is owners’ equity, or the amount that belongs to the owners of the business.
What are the TWO separate equations for a customer buying an item?
- 1- REVENUE: When someone buys something: Assets increase (Cash) & Owners equity increases
- 2- EXPENSE: When you RECORD the expenses for what it took to pay for that item/service: Assets Decrease (inventory decreases) & Owners Equity Decreases (What you paid for the item)
What are the TWO parts to buying on credit?
1- When asking for credit- money, inventory, etc: Assets Increase & Liabilities increase!
2- When the credit is paid off: Assets Decrease and Liabilities Decrease
2 primary methods of accounting
CASH
Used by very small businesses
ACCRUAL
Revenue is recognized when the merchandise is delivered
Realization Principle
if a business has delivered a good it can recognize revenue! Or at the time they sell the goods- if they receive them!
Matching Principle
One of the principles behind Accrual Accounting which states that expenses should be recognized in the same period in which the related revenue is recognized rather than when the related cash is paid.
Also- notes from the lesson: When cash is actually received from the sale 2 adjustments are made to assets
What happened here. (Most likely)
- the customer paid $500 for the item
- it cost the store $250 to stock
- Since you can count revenue BEFORE you receive it… to edit the equation when you get the $$, you + the amount $500 ($ you received from customer ) and - the amount $500 from assets (Because you can no longer receive that $ from the customer.
What is this an example of:
$1200 for a yearly membership of Bikram Yoga. Payment is recorded THROUGHOUT THE YEAR not at the time of payment. ($100 for each month) The studio is required to repay this debt through services, so this is a liability!
Advance Payment/Deferred Revenue
What does a sold gift card transaction look like?
Prepaid Expense
A prepaid expense is an asset that represents the right to receive goods or services in the future. Some common examples are prepaid rent or prepaid insurance, where a company pays for rent or insurance in advance of the coming month or year. At the time of the payment, the transaction is recorded as an asset, and as time passes, the asset is reduced and the expense is recognized. Remember that prepaid expenses are NOT expenses.
What’s the name of the AMERICAN board & the INTERNATIONAL board?
America:
- Financial Accounting Standards Board
- GAAP- Generally Accepted Accounting Principles
Everyone else
- International Accounting Standards Board
- IFRS- International Financial Reporting Standards
Conservatism
This principle recognizes that there are some estimates involved in accounting and says that accounting should reflect the more cautious estimated valuation rather than the more optimistic one. For assets it means recording the lower valuation while for liabilities it means recording the higher possible valuation. For revenues and gains it means recording them when they are reasonably certain but for expenses and losses it means recording them when they are reasonably possible.
The entity concept
The entity concept refers to the fact that a business is a separately identifiable entity. Thus, the accounts of a business should be separate and distinct from the accounts of the owners and managers of the business. In addition, financial records should be kept and reported for each separate entity, especially in the case of multi-national companies and large companies with subsidiaries.
Relevance
Relevance means that the information is useful and capable of influencing the decision of the users of the financial statements.
Reliability
Reliability means that the information faithfully represents the underlying economics. The three dimensions of reliability are:
- validity
- verifiability
- and unbiasedness.
Suppose you are CEO of a pharmaceutical company and there are early reports of potential bad reactions to one of your drugs. This information would be regarded as more:
Relevant OR Reliable
RELEVANT
Depending on the severity of the reactions, this may be relevant for both financial and health reasons.
It’s not the other because…Without knowing the source of these early reports, this information would not necessarily be considered reliable.
The historical cost principle
The historical cost principle refers to the fact that transactions are recorded at the cost that existed at the time the transaction occurred. In the case of assets, it means that their value in the financial records is shown at historical cost, rather than current market value. When combined with the principle of Conservatism, it means that an asset’s value may be reduced if it is deemed to have permanently lost value but it cannot be increased if it is deemed to have gained value.
EX: Real estate prices in Orderville have increased dramatically over the last five years. Although the land under Chad’s office building is currently believed to be worth $500,000, it is recorded at $250,000 because that is the price he paid for it.
Consistency
Although accounting guidelines allow some degree of discretion in how transactions are recorded, the consistency principle requires that the methods be consistently applied by the company over time in recording and reporting unless there is a sound reason to change them. Consistency refers only to consistency over time; it does not imply consistency across accounts. For example, a company may properly choose to use LIFO for US inventory valuation and FIFO for international inventory valuation, and this is not a violation of the consistency principle.
Materiality
Something is considered to be material if it is reasonably likely to impact the decision-making of those who are using the accounting data or financial reports. Businesses are only required to do detailed record-keeping and reporting for items that are material.
EX: As Tyler is reviewing his business’ financial information at the end of the year, he realizes that no information was recorded throughout the year about the glue used to fix odds and ends around the office. Tyler decides that the cost of the glue wasn’t enough to worry about figuring out.
Money Measurement Principle
The money measurement principle refers to the fact that only values that can be measured in monetary terms should be recorded in the financial accounting records.
EX: You are the founder of an independent film company and your first film release has received very good reviews and has also been nominated for several awards. You are hopeful that this will help financially but your accountant has not recorded anything related to this good publicity.
This is an example of the money measurement principle. The value of the good publicity cannot be reliably estimated in monetary terms.
Going Concern
A company is considered to be a going concern if the entity is expected to remain in operation and be able to satisfy all commitments and obligations and realize the benefits and values of all assets for the indefinite future. If there is evidence to the contrary, the business may no longer be considered a going concern.
Universal Graphics has used straight-line depreciation on all its copiers and printers since its inception in 1943. This year, the CFO wants to change the method to double declining balance for all machinery because she believes it more accurately reflects how the machines are used up.
From the options given below, which accounting principle is most important to consider before possibly making this change?
- Relevance
- historical Cost
- Money Measurement
- Consistency
The principle of Consistency requires that the accounting methods be consistently applied by the company over time in recording and reporting unless there is a sound reason to change them. If the motivation is to more accurately match expenses to revenues, the company may find this reason more compelling than consistency and decide to make the change.
Party Planners, an event planner and producer, records and tracks every cost in detail and provides an itemized invoice for $150,000 to Ivy University for their services at the commencement ceremony. However, Ivy University simply records the entire amount of the invoice as part of their overall Event Expenses account.
The reason for the different levels of detail between the two entities is related to the accounting principle of:
- Conservatism
- Entity Concept
- Materiality
- Reliability
Materiality
The decision about the level of detail in grouping transactions into financial accounts is related to how significant, or material, the transactions are. This often means large and small companies group transactions differently.
An Asset…
To be considered an asset, an item must:
- Be purchased at a cost that is measurable
- Produce probable economic benefit in the future
- Result from a past event
- Be owned or controlled by the entity
- Under these standards, businesses will not record some items as assets though they may initially appear to be.
Liabilities…
Generally, a liability must satisfy the following:
- It must impose a probable economic obligation on economic resources in the future
- The obligation has to be to another entity
- The event that created the obligation must have occurred in the past
EQUITY
“the residual interest in the assets of an entity that remains after deducting its liabilities.”
In other words: Owners’ Equity = Assets - Liabilities
In essence, equity is simply the resources of the business that belong to the owners. If you add up all of the resources of the business (assets), and subtract all of the claims that third parties (such as lenders and suppliers) have against those assets, you’ll end up with what is left for the owners (equity).
As you’ve seen throughout this module, most adjustments to equity take place when businesses record a transaction in the form of revenues and expenses, gains and losses, or contributions by owners. Another situation we haven’t mentioned that affects equity is when a company makes a distribution to the owners—for example, when a public company pays dividends or buys back shares of its own stock that were previously issued. This transaction reduces the total amount of equity outstanding in the business.
OTHER WORDS THAN MEAN EQUITY
Small businesses with a single owner, known as a sole proprietorship, will typically use the term owner’s equity.
Large corporations that sell shares of stock refer to the equity section as stockholders’ or shareholders’ equity.
Which of the following is an example of owners’ equity? Select all that apply.
- Shares of a competitor’s stock owned by the business
- Cash received from owner contributions
- Net income for the first six months of the fiscal year
Net income for the first six months of the fiscal year
All revenues and expenses, and therefore Net Income, are part of the owners’ equity of the business.
Shares of another company are an investment that is expected to produce future economic benefit, so they are an asset.
And Cash is also an asset!
Revenue
“the money that a business receives from providing goods or services to a customer.” One important difference, however, is the stipulation that the goods or services must be related to the entity’s central operations. If a machine tool company sells a building that it no longer uses, the funds received from the sale are not considered revenue because they are not related to the primary business of the company.
Certain other criteria exist for a business to be able to recognize revenue under accrual accounting. The firm must have provided the service or delivered the good to the customer, referred to as earned in accounting, and it must either have received cash from the customer or be confident that the customer will pay, known as realizable in accounting—and in the latter case, it must have an arrangement with the customer that specifies the amount that will be transferred for the good or service.
Goods HAVE to be delivered for it to be considered revenue!
Expenses
“outflows or other using up of assets or incurrence of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations.”1
Again, this is not so different from our earlier definition of expenses as “the costs associated with providing goods or services to a customer.”
Under accrual accounting, expenses are generally recognized in the period in which the revenues that they help generate are recognized. As with revenues, expenses are costs associated with the core operations of the business. While the business may experience outflows of money and assets on other items, these outflows are recorded in other forms.
Accounts payable
Accounts payable include all the short-term debts or obligations. For example, if a restaurant owes money to a food or beverage company, those items are part of the inventory, and thus part of its tradepayables.
Accounts receivable
Accounts receivable are amounts a company has a right to collect because it sold goods or services on credit to a customer. Accounts payable are liabilities. Accounts receivable are assets.
