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
Net Book Value formula
Net Book Value = Historical Cost - Accumulated Depreciation
Depreciation Expense
the cost of tangible assets be spread over its useful life, and in each accounting period an expense be recorded to reflect the reduction in the useful life of the asset
What is the assumed lifetime for land?
Indefinite, therefore never depreciated
Ammortization
cost from using an intangible non-current asset
Gross Margin Percentage Formula
= (sales - cogs)/sales *100
= gross margin/sales *100
What does gross margin percentage tell you?
It represents the mark up on the cost of the products sold by a company. Provides insights into a company’s pricing strategy and practices.
Return on Sales Percentage Formula
=net income / sales
What does return on sales percentage telly you?
provides financial statement users useful insights into a company’s pricing strategy and its ability to control costs
double-entry accounting system
records the dual effects of each financial transaction
liabilities and owners’ equity accounts - debit vs. credit
decrease- debit
increase - credit
asset accounts - debit vs. credit
increase - debit
decrease - credit
sales account - debit vs. credit
decrease- debit (when sale is reversed)
increase - credit (sale is an increase in OE)
expense account - debit vs. credit
increase - debit > decrease in OE
decrease - credit > when reversed/reduced appropriate expense accounts are credited
direct method statement of cash flows
summarizes the transactions that have been posted to the cash ledger account during the period
Cash flows from operating activities
directly related to the delivery of goods and services that generate revenues and expenses in the income statement
ex. cash received from customers, cash paid to suppliers of good and services, cash paid to employees, interest/taxes paid
Cash flows from investing activities
relate to the purchase and sale of long-lived assets
Cash flows from financing activities
cash effects of raising or retiring debt, new issues or repurchases of equity, and the payment of any dividends
direct method for cash flow statement
uses the actual cash inflows and outflows from the company’s operations
indirect method for cash flow statement
takes the company’s net income and adds or deducts balance sheet items to determine cash flow. Go from economic impact of the period (net income) to the cash impact»_space; reverse some items, like de-accruals
Why use the indirect method?
1) FASB requires entities that use direct method to present a separate reconciliation of net income to operating cash flows using the indirect method
2) provides readers with information about the extent to which and the means by which the entity’s net income of the period has resulted in operating cash flows
All but which current liability are added to net income in indirect accounting?
Increases in current liabilities other than short-term debt are added to net income.
Users of accounting information can be divided into what two categories?
Financial accounting
& managerial accounting
(also tax accounting which we won’t cover)
corporation
form of business organization that is characterized by a large number of owners who are not involved in managing the day-to-day operations of the company
shares of sotck
corporation issues these in exchange for stock
stockholders
owners of a corporation
sole proprietorship
single owner who typically manages the daily operations
partnership
two or more owners who are also usually involved in managing the business
LLC
limited liability company - flexibility similar to partnership but lack of liability like corporation
creditors
someone (or an entity) to whom an obligation is owed > interested in potential borrower’s ability to repay
use accounting information to help determine loan terms, loan amounts, interest rates, and collateral.
suppliers
use financial information to establish credit sales terms and to determine their long-term commitment to supply-chain relationships.
board of directors
Directors are elected by the shareholders to represent shareholder interests and oversee management.
balance sheet
company’s investments and sources of financing using the accounting equation
point of time
income statement (statement of earnings)
reports the results of operations
-period of time
statement of stockholders’ equity
details changes in owner financing
statement of cash flows
details the sources and uses of cash
-period of time
Net Income vs. Operating Cash Flow
Net income is the profit a company has earned for a period, while cash flow from operating activities measures, in part, the cash going in and out during a company’s day-to-day operations
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.
Securities and Exchange Commmision (SEC)
independent agency of the United States federal government, created in the aftermath of the Wall Street Crash of 1929. The primary purpose of the SEC is to enforce the law against market manipulation
Sarbanes-Oaxley Act (SOX)
2002 act aimed to increase the level of confidence that external uses, particularly investors, have in the financial statements through improving deficient internal controls like increasing management responsibility).
Critiques: costly for small businesses, accountability makes veryone more conservative
Public Company Accounting Oversight Board (PCOAB)
board to approve auditing standards and monitor the quality of financial statements and audits
role of auditors
provide an opinion as to whether the statements present fairly and in all material respects a company’s fiancnial condidition and the results of th eoperations
two characteristics of an asset to be reported on the balance sheet
1) it must be owned or controlled by the company
2) it must possess probable future benefits that can be measured in monetary units
Factors that could influence a ratio
- different product market
- regulation differences across country and time
- different customer or supplier demographics
- different management policies towards assets and liabilities
- measures can be altered by management for cosmetic effect (ex. delaying inventory order)
- fiscal year differences between companies end, ex. 12/31 or end 1/31
contributed capital
the total value of a company’s equity purchased by investors directly from a company. In other words, it indicates the total amount of money that the shareholders paid to a company to acquire their stakes in it.
three characteristics for a liability to be reported in the balance sheet
- future sacrifice is probable
- the amount of obligation is known or can be reasonably estimated
- the transaction or event that caused the obligation has occurred
executory contract
- future sacrifice is probable and 2. the amount of obligation is known or can be reasonably estimated are satisfied but 3. the transaction or event that caused the obligation has not occurred
ex. purchase order > disclose this in notes because useful information for investors
accrued liabiliites
obligations for expenses that have been recorded but not yet paid - ex. accrued compensation payable. (current liability)
deferred (unearned) revenues
obligation crated when the company accepts payment in advance for goods or services it will deliver in the future ex. deposits (current liability)
contributed capital (aka paid-in capital)
net funding that a company has received from issuing and reacquiring its shares.
= common stock + additional paid in capital - treasury stock
common stock
the capital received from the primary owners of the company, total common stock is divided into shares. share is smallest fractional unit of ownership
treasury stock
the amount paid for its own common stock that the company has reacquired, which reduced contributed capital
additional paid-in-capital
amounts received from the common shareholders in addition to the par value or stated value of the common stock
earned capital
cumulative net income (and losses) retained by the company (not paid out to shareholders as dividends).
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
non operating revenues and expenses
relate to the company’s financing and investing activities and include interest revenue and interest expense > may also be segmented by nonrecurring revenues/expenses and continuing revenues/expenses
expense recognition
expenses are recognized when assets are diminished (or liabilities increased) as a result of earning revenue or supporting operations
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
cash operating cycle
time between paying for goods and employee services and the receipt of cash form sales for cash or o
n credit
Difference between note payable and account payable”?
Note payable is linked to long term, account payable to short term
supplies - current or non current?
current because used in normal course of business within the year
FSET
table of balance sheet and income statement formulas as columns and transactions as rows
unadjusted trial balance
list of all the business accounts that are set to have balances at the end of an accounting period, before any adjusting entries are made (adjustments such as deferred and accrued
deferrals
allocating assets to expense and allocating unearned revenues to revenue
accruals
a means of recording an expense that was incurred in one accounting period but not paid until a future accounting period (accured revenues / accrued expenses)
depreciation
the process of allocating the costs of equipment, vehicles, and buildings to the periods benefiting from their use is called depreciation
contra asset account
add depreciation to another line item, don’t change asset amount > allows you to keep and reference the book value of the asset
deferred revenue
receive fees for products or services before those products or services are rendered (Ex. deposit or gift card)
deferred (prepaid expenses)
pay before expense incurred ex. prepaid insurance
accrued revenue
provide services during a period that are neither paid for by customers nor billed before the end of the period
ex. earning interest which is paid out on the 5th of every month
accrued expenses
companies often incur expenses before paying them ex. wages, interest, utilities, and taxes, paying interest
three primary inflows and outflows on cash flow statement
operating, investing, and financing activities
temporary accounts
income statements - show net change so don’t carry over balances
permanent accounts
carry over balance > balance sheets
closing process
takes the end of period balances in the temporary accounts and moves them to a permanent account
close revenue accounts
debit each revenue account for an amount equal to its balance and credit RE for the total of the revenues
close expense accounts
credit each expense account for an amount equal to its balance and debit RE for the total of expenses
liquidity
ability to pay near tern liabilities and take advantage of investment opportunities
solvency
ability to pay long-term liabilities
restricted cash
cash balances not immediately available (Ex. lender requires certain amount of cash on hand)
financing activities
cash from shareholders, returns cash to shareholders, borrows from creditiros, and repays amount borrowed
investing activites
involving
1) acquisition and disposal of PPE Assets and intangible assets
2) sale of gov securities and securities of other companies not classified as cash equivalents
3) lending and subsequent collection of money
operating activities
broadly any cash receipt that is not investing or financing (ex. selling goods, taxes, interest, etc)
performance obligation
process of identifying promises to provide goods or services to a customer in a contract as the unit of account for applying revenue standards
how do you decide if two items are distinct performance obligations
if they often sell them separate then they are two. if they are distinct but sold at a discount then you evenly discount the entitites
buying a flight: miles and flight are separate because people can buy
buying a car: car + standard manufacturers’ warranty are together
variable consideration
an amount that can change and is not fixed. It can include things like:
discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, and penalties.
consignment sale
Consignment sales are a trade agreement in which one party (the consignor) provides goods to another party (the consignee) to sell.
contract liability
refers to an entity’s obligation to transfer goods or services to a customer for which the entity has received consideration (or the amount is due) from the customer (often labeled unearned revenue or deferred revenue) > this is reduced when contract is fulfilled
contract asset
unbilled receivables -
Unbilled AR is an Asset account on the balance sheet that represents amounts recognized as revenue for which invoices have not yet been sent.
credit sales
sales on account - common with suppliers
Credit sales are transactions where a customer pays for a product or service at a later date, rather than in cash at the time of purchase. Before the exchange, the payment terms are set, including when the full payment is due and how it will be paid. Credit sales often include a down payment, where the customer pays a percentage of the total amount upfront
collectability risk
not all creditors may be able to pay > suppliers are often the last to get paid
net relizable value
net amount seller expects to collect
allowance for doubtful (uncollectible) accounts
contra-asset account that is associated with accounts receivable and serves to reflect the true value of accounts receivable
aging analysis
a tool used by accountants and investors to evaluate a company’s accounts receivable (AR) for irregularities. It involves categorizing unpaid customer invoices and credit memos by date ranges, usually 30 days, to determine how long a bill has been unpaid.
cost to cost analysis
a financial calculation that compares a project’s total expected costs to the costs incurred so far. It’s used to determine the percentage of completion of a project and to recognize profit and revenue in long-term projects.
Statement of Shareholders’ Equity (SSE)
Explains the causes of the change in shareholders’ equity over a period of time.
Statement of Comprehensive Income (SCI)
explains the change in comprehensive
income over a
- period of time
Footnotes
provide additional explanation
regarding the preparation and interpretation of a firm’s financial statements.
Auditor’s Opinion
reports on the auditor’s evaluation of the accuracy or “fairness” of the financial statements and internal controls.
managerial accounting
provide information about firm performance and resources to managers and internal stakeholders of the firm for purposes of planning, decision making, and control.
-follows certain norms and expectations
financial accounting
provide information about firm performance and resources to investors and creditors of the firm fo purposes of valuation
-abides by a voluminous set of rules and regulations
E xecutury contracts - impact?
None!
E xecutury contracts - impact?
None!
Two ways to measure assets:
Historical cost and fair value cost: HC is most common - FV is limited and only goes down
Two ways to measure assets:
Historical cost and fair value cost: HC is most common - FV is limited and only goes down
Treasury stock
Common stock of the firm owned by the firm
Treasury stock
Common stock of the firm owned by the firm
