The Accounting Equation Flashcards
Assets= Liabilities + Stockholders Equity (common Stock + retained earnings)
The Accounting Equation
Assets= Liabilities + Stockholders Equity (common Stock + retained earnings)
Net Income Equation
Revenues – Expenses = Net Income
Financial Resources
Investors and Creditors
Organizations need these to establish and operate their businesses
FASB
Financial Accounting Standards Board
GAAP
Generally Accepted Accounting Principles
Asset Source
Increase total assets, Increase total claims
Ex. Borrowing cash from the bank
Asset Exchange
Increase one asset, decrease another asset
Ex. Purchasing equipment with cash
Asset Use
Decrease total assets, decrease total claims
Ex. Purchasing advertising expense with cash
Operating Activities
The functions of a business directly related to providing its goods and services to the market. These are the company’s core business activities, such as manufacturing, distributing, and selling a product or service.
Financing Activities
Transactions with creditors or investors used to fund either company operations or expansions (and dividends).
Investing Activities
Consist of buying and selling long-term assets and other investments.
Accrual Accounting
Required by generally accepted accounting principles (GAAP). Virtually all major companies operating in the United States use it. Its two distinguishing features are accruals and deferrals.
The objective of accrual accounting is to improve matching of revenues with expenses.
Accrual
Describes a revenue or an expense event that is recognized (or recorded) before cash is exchanged.
Deferral
Describes a revenue or an expense event that is recognized (or recorded) after cash has been exchanged.
The Accounting Cycle
The holistic process of recording and processing all financial transactions of a company, from when the transaction occurs, to its representation on the financial statements.
The cycle repeats itself every fiscal year as long as a company remains in business.
Steps in an Accounting Cycle
Record transactions, adjust accounts, prepare statements, close nominal accounts
Matching Concept
Cash basis accounting can distort the measurement of net income because it sometimes fails to properly match revenues with expenses.
The problem is that cash is not always received or paid in the period when the revenue is earned or when the expense is incurred.
The Closing Process
At the end of the accounting period, organizations need to “close the books”.
Balance in the temporary accounts (revenue, expense, and dividends) are transferred (closed) to the permanent account, Retained earnings.
Closing entries are prepared and posted to the general ledger.
Temporary Accounts
Track financial results for a limited period of time.
A general ledger account that begins each accounting year with a zero balance.
Then at the end of the year its account balance is removed by transferring the amount to another account. This is done through closing entries.
Also referred to as nominal accounts.
Temporary Accounts
Expenses, Revenues, Dividends
Permanent Accounts
Tracks financial results from year to year.
Accounts that are not closed at the end of the accounting period, hence are measured cumulatively.
Refer to as asset, Liabilities and capital accounts- those that are recorded in the balance sheet
Also known as: Real accounts, balance sheet accounts
Permanent Accounts
Liabilities, Assets, Equity
Merchandising Businesses
Generate revenue by selling goods. The goods purchased for resale are called merchandise inventory.
Product Costs
Costs that are included in inventory
Period Costs
Costs that are not included in inventory. They are sometimes called Selling and Admin Costs.
Costs of Goods Available for Sale
Beginning Inventory balance + Inventory during the purchase
Merchandise inventory (balance sheet)
Costs of goods sold (Income statement)
Matching Principle
All costs, product and period, will eventually be captured on the Income Statement. However, when you are holding goods for future sale, these costs are initially shown in inventory, which is a balance sheet account.
Gross Margin (or Gross Profit)
First section on an income statement for a merchandising company
Sales revenue – Cost of goods = Gross Margin
Perpetual Inventory System
Inventory account is adjusted perpetually (continually) throughout the accounting period
Inventory increased for each item purchased
Inventory decreased for each item sold
Cash Discounts
A deduction from the invoice price granted to induce early payment of the amount due.
FOB Shipping Point
Terms indicating that the buyer must pay to get the goods delivered (the buyer will record fright-In and the seller will not have any delivery expenses.
With terms of FOB shipping point the title to the goods usually passes to the buyer at the shipping point.
This means that the goods in transit should be reported as a purchase of inventory by the buyer.
FOB Destination
Terms indicating that the seller will incur the delivery expense to get the goods to the destination.
With terms of FOB destination, the title to the goods usually passes from the seller to the buyer at the destination.
This means that the goods in transit should be reported as inventory by the seller, since technically the sale does not occur until the goods reach the destination.
Shrinkage
Most merchandising companies experience some level of inventory shrinkage, a term that reflects decrease in inventory for reasons other than sales to customers.
EX. Lost, Damaged, Stolen Inventory.
Sales Discounts
Price reductions offered by sellers to encourage buyers to pay promptly.
Sales Returns
Inventory returned by customers.
Sales Allowances
Refers to reduction in the selling price when a customer agrees to accept a defective unit instead of returning it to the seller.
Income statement for Merchandising Business
Calculate gains and losses and show how they are presented on a “multistep” income statement.
Compares sales revenue with the cost of the goods that were sold to produce that revenue.
The difference between the sales revenue and the cost of goods sold is called gross margin.
Next, the operating expenses are subtracted from the gross margin to determine operating income.
Operating Income
The amount of income that is generated from the normal reoccurring operations of a business.
Items that are not expected to reoccur on a regular basis are subtracted from the operating income to determine the amount of net income.
Purpose of Internal Control Systems
Internal control is the process designed to ensure reliable financial reporting, effective and efficient operations, and compliance with applicable laws and regulations.
Safeguarding assets against theft and unauthorized use, acquisition, or disposal is also a part of internal control.
An Integrated Framework
- Control Environment- Integrity and ethical values of a company
- Risk Assessment- Management identification of potential risks
- Control Activities- Internal controls
- Information and Communication- Internal and external reporting process
- Monitoring- Over time assessment and correction of internal controls
Internal Controls
- Separation of Duties
- Quality of Employees
- Bonded Employees
- Required Absences
- Procedures Manual
- Authority and Responsibility
- Prenumbered Documents
- Physical Control
- Performance Evaluations
- Limitations
Controlling Cash
Cash receipts should be recorded immediately.
A deposit ticket should be used for all deposits.
Cash disbursements should be made by prenumbered check.
A monthly bank reconciliation should be prepared by an independent party.
Up to date signature card should be maintained.
Reconciling the Bank Account
The bank reconciliation reports on the differences between the balance on the bank statement and the balance in the general ledger cash account. The reconciliation results in the true cash balance that will appear on the balance sheet.
Correction of Errors
If an error is found on the bank statement, an adjustment for it is made to the unadjusted bank balance to determine the true cash balance, and the bank is notified. An error made by the depositor requires an adjustment to the book balance.
Certified Check
A certified check is guaranteed payment by the bank and is deducted when the bank certifies that the check is good.
They, therefore, have been deducted by the bank in determining the unadjusted book balance.
The Fraud Triangle
Pressure, Opportunity, Rationalization
Pressure
The first leg of the fraud triangle.
Non-sharable financial problem. Perceived financial need.
• Medial bills, household expenses, living beyond one’s means, gambling debts, intimidation from supervisors.
These financial problems are usually personal to that person. But, they are too ashamed by the problem that they are unwilling to share with others.
Supervisors may put pressure on employees to perform, which may lead to false financial information.
Opportunity
The second leg of the fraud triangle is an opportunity that exists within a company for fraud to take place.
Usually occur from a lack of internal controls within a company.
For example, the violator here feels that he/she can take advantage of the situation without getting caught.
Of course, there has to be a certain level of technical skill to be able to define an opportunity which is why several violators find opportunities within their own job function.
Rationalization
The third and final component of the fraud triangle.
Many violators never feel that they were actually a criminal.
This is because they have rationalized to themselves that the misdeed was ok.
In fact, not many violators feel justified.
• No raises this year- the organization “owes” me.
• Money spent on a better “purpose”
• “everybody does it”
Fraud Red Flags
- Missing Documents- missing check numbers or gaps in reconciled checks
- Complaints- Disgruntled employees may think it’s ok to commit fraud
- Excess Purchases- May indicate a fake vendor
- Inventory Shortages- Employees could be taking the inventory
- Excessive Voids- Voiding cash receipts could be fraud
- Abnormal Invoice Volume
- Mail Drop or “Ghost Address”- “Ghost” employees
