Terms Flashcards
What are the three sections on the balance sheet?
entity’s assets, liabilities and owners’ equity
Balance Sheet (statement of financial position)
Report of the organization’s financial situation at a particular point in time
Statement of Cash Flows
details the sources and uses of cash by the entity over an accounting period
What types of business activities are organized in the statement of cash flows?
operating, investing and financing
A balance sheet is prepared for
A) a point in time
B) to cover an accounting period
A) a point in time
An income statement is prepared for
A) a point in time
B) to cover an accounting period
B) to cover an accounting period
An statement of cash flows is prepared for
A) a point in time
B) to cover an accounting period
B) to cover an accounting period
Assets
Economic resources acquired in a business transaction that are obtained or controlled by an entity, and are expected to produce future economic benefits
Liabilities
An obligation to transfer economic resources to entities outside the business. Represent the capital provided to the business by creditors
Owners’ Equity (aka stockholders or shareholders equity)
represents the residual interest of the owners in the business > capital that has been invested by the shareholders
Sales Revenue or Revenues
sum of economic benefits the entity has earned during the accounting period in exchange for the goods and services it has provided to its customers
Expenses
Assets used or liabilities incurred by the entity during an accounting period to provide the goods and services that generated revenue during the period
cost incurred to generate revenue
Net income / Profit / Net Profit (bottom line)
difference between sales and expenses of the accounting period
income = revenue - expenses
Operating activities
activities related to the delivery of goods and services. Statement of cashflow records the cash impact of these activities
investing activities
activities related to the purchase and sale of long-lived assets. The impact of such activities on the cash account recorded in the statement of cash flow
financing activities
relate to the borrowing or retiring of debt and to increasing or decrease owners’ equity in the firm. The impact of such activities on the cash account recorded in the statement of cash flow
entity concept (accounting concept)
accounts are kept for an entity as distinct from the people who own, run or do business with the entity
money measurement concept (accounting concept)
financial accounting deals only with things that can be represented in monetary terms (ex. employee loyalty isn’t on the balance sheet)
going concern concept (accounting concept)
an entity is expected to remain in operation for the indefinite future
consistency concept (accounting concept)
an entity should use the same accounting methods and procedures from period to period unless it has a sound reason to change methods. Reduces likelihood of opportunistic/whimsical changing
materiality concept (accounting concept)
an entity need only apply proper accounting to items that are material, i.e., significant to potential users of the financial statements. For instance - paper clips can be expensed immediately, whereas accounting treatment for a van may be different.
When is an item material or not?
general rule is that, “An item is material if its disclosure would impact the decisions of the users of the accounts.”
The quality of financial accounting output depends on X and Y
relevance and reliability
What is favored - relevance or reliability?
Reliability
Two attributes of relevance
useful and timely
Two attributes of reliability
objective and verifiable
Accrual Accounting
Record economic impact of each transaction
Cash-Basis Accounting
Record cash impact of each transaction
Generally Accepted Accounting Principles (GAAP)
guidelines that accountants, managers and auditors must follow while preparing and auditing accounting information for external reporting purposes
Financial Accounting Standards Board (FASB)
determines GAAP in US
International Accounting Standards Board (IASB)
undertaken a major effort to harmonize accounting standards around the world - International Financial Reporting Standards (IFRS)
IFRS vs. GAAP
IFRS - principle based, more likely to reflect the substance of the transaction
GAAP - rule based, more likely to reflect the form of the transaction. Expected to become more principle based
Accounting Equation / balance sheet equation
total assets = total liabilities + owner’s equity
owner’s equity = assets - liabilities
To be recorded as an asset, an economic resource must meet four requirements
1) Acquired at measurable cost
2) Obtained or controlled by the entity
3) Expected to produce future economic benefits
4) Arises from a past transaction or event
Current Assets
include cash and those assets that are expected to be converted into cash or consumed within 12 months of the balance sheet date. (cash, marketable securities, accounts receivable, inventory, prepaid expenses)
Non-current assets
assets that are expected to provide economic benefits for periods longer than a year (long-term financial investments, PPE, operating lease right-of-use asset, intangible and other assets ex. patents)
accounts receivable
money owed to brand
tangible asset
physical substance
intangible asset
not physical
liability
represents an obligations of the entity to other parties
To be recorded as a liability, an obligation must meet three requirements
1) It involves a probable future sacrifice of economic resources by the entity
2) The economic resource transfer is to another entity
3) The future sacrifice is a present obligation, arising from a past transaction or event
Current liabilities
obligations that are expected to become due within 12 months of the balance sheet date.
Non-current liabilities
obligations that are expected to become due more than 12 months past the balance sheet date.
accounts payable
money owed by business (current liability)
dual aspect concept (accounting concept)
formalizes the idea that there are two sides to every accounting transaction. Recording both sides of each transaction is known as double-entry bookkeeping
historical cost concept (accounting concept)
requires that transactions be recorded in terms of their actual price or cost at the time the transaction occurred
Purpose of financial ratios
assess the financial position and performance of an entity
Current Ratio
current assets / current liabilities
> assess an entity’s ability to meet its current obligations
What is a good current ratio and what does it mean if too high / too low?
varies by industry, but rule of thumb is that min of 2
too high - locking up productive capital
too low - may not be able to satisfy obligations
Total Debt to Total Equity - why useful?
total debt - capital that accrues interest and has to be repaid to lenders»_space; force bankruptcy if not repaid
equity capital - capital that does not demand interest and does not have to be repaid»_space;if insolvent get repaid what’s left after debt
Useful for judging an entity’s long-term financial viability. The ratio of all interest bearing debt on the balance sheet to total equity.
debt/equity ratio - what does it mean if high or low compared to peers?
significantly higher than that of its peers, financial statement users may be concerned about its ability to make the required payments to its debt holders and the company’s long-term solvency may be questioned.
total debt to equity ratio that is significantly lower than that of its peers, financial statement users may question whether the company is being aggressive enough in pursuing profitable growth opportunities by raising debt when necessary to finance those opportunities.
Sales
increases in assets or decreases in liabilities during a period resulting from delivering goods, rendering services or other activities constituting the entity’s central operations
Gross Margin (Gross Profit)
Gross Margin = Sales - Cost of goods Sold
Operating Expenses
Relate to the operations of the business (ex. marketing, selling, and administrative expenses incurred in running.a business)
Often reported as a single account: selling, general, and administrative (SG&A) expenses
Operating Income (Operating Profit)
Gross Margin - Operating Expenses
Measure of the profit generated from the day-to-day running of the business
Interest expense
Cost of debt financing for the accounting period
Interest income
interest from any invested cash during this accounting period
Earnings/ Income before Income Taxes (EBIT)
EBIT = operating income - interest expense
(+ interest income)
Income Tax Expense
estimate that will have to be paid on the profit
Net Income / Net Profit (loss) / Profit (loss)
earnings of the entity net all of the expenses
What links the income statement to the balance sheet?
Retained Earnings
What is the formula linking the income statement to the balance sheet?
Dividends
Distributions of earnings to owners, usually in the form of cash. Payment of a dividend reduces the Retained Earnings account
What two events change the retained earnings during an accounting period?
First, the Net Income (loss) earned by the entity during the period increases (decreases) the retained earnings account. Second, any dividends paid (distributions made to investors) during the period reduce the retained earnings account.
Why are dividends not recorded on the income statement?
The payment of dividends is not an expense; it is a distribution of equity capital to investors. Hence, the payment of dividends is not recorded on the income statement; instead, it directly reduces the retained earnings account.
GAAP Revenue Recognition
GAAP, among other requirements, recognizes revenue when it is “earned.” and realized (or realizable)
table paid for and delivered
IFRS Revenue Recognition
IFRS recognizes revenue when the “risks and rewards of ownership are transferred.”
IFRS recognizes revenue when all the following conditions have been satisfied:
1) The seller has transferred to the buyer the significant risks and rewards of ownership of the goods;
2) The seller retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the good sold;
3) The amount of revenue can be measured reliably;
4) It is probable that the economic benefits associated with the transaction will flow to the seller; and
5) The costs incurred or to be incurred in respect of the transaction can be measured reliably.
Realization Concept (Accounting Principle)
tells us when to recognize revenue (different definitions between GAAP And IFRS)
Matching Concept (Accounting Principle)
states that expenses should be recognized in the same period as the relevant revenues are recognized. Costs related to this period’s activities but which are not directly related to products and services sold, are expensed this period.
How is this type of cost recorded/recognized as expense?
Associated directly with products and services offered for sale
Recognized as expense in the same period as revenue form those products and services is recognized
How is this type of cost recorded/recognized as expense?
Not associated directly with products and services or with future period revenues
Recognized as expense in the period in which they are incurred
How is this type of cost recorded/recognized as expense?
Associated with future period revenues
If meet asset definition, recorded as assets in the period in which they are incurred;
recognized as expenses when the future revenue is recognized
Conservatism Concept (accounting principle)
recommending that prudence be exercised in recording revenues and expenses.
income statement
1) revenues should be recognized only when reasonably certain, but
2) expenses should be recognized as soon as reasonably possible
balance sheet
1) record assets when reasonably certain
2) record liabilities as soon as reasonably possible
3) if two different estimates of a balance sheet amount were equally acceptable, the conservatism concept would guide accountant to record the smaller amount when measuring assets and the larger amount for liabilities
Retained Earnings
a firm’s cumulative net earnings or profit after accounting for dividends
Gross Margin Percentage Formula
= (sales - cogs)/sales *100
= gross margin/sales *100
Return on Sales Percentage Formula
=net income / sales
Name three links (articulation) of the four main statements
- The statement of cash flows links the beginning and ending cash in the balance sheet.
- The income statement links the beginning and ending retained earnings in the statement of stockholders’ equity.
- The statement of stockholders’ equity links the beginning and ending equity in the balance sheet.
Public Company Accounting Oversight Board (PCOAB)
board to approve auditing standards and monitor the quality of financial statements and audits
retained earnings
accumulated earnings that have not been distributed to stockholders as dividends.
accumulated other comprehensive income or loss
accumulated changes in equity that are not reported in the income statement
accounting relation: assets
(balance sheet)
debit: increase
credit: decrease
accounting relation: liabilities
(balance sheet)
debit: decrease
credit: increase
accounting relation: dividends
(balance sheet)
debit: increase
credit: decrease
accounting relation: shareholders equity
(balance sheet)
debit: decrease
credit: increase
accounting relation: revenue
(income statement)
debit: decrease
credit: increase
accounting relation: expense
(income statement)
debit: increase
credit: decrease
FSET
table of balance sheet and income statement formulas as columns and transactions as rows
