The Accounting Equation

Question 1

The Accounting Equation

Answer 1

Assets= Liabilities + Stockholders Equity (common Stock + retained earnings)

Question 2

Net Income Equation

Answer 2

Revenues – Expenses = Net Income

Question 3

Financial Resources

Investors and Creditors

Answer 3

Organizations need these to establish and operate their businesses

Question 4

FASB

Answer 4

Financial Accounting Standards Board

Question 5

GAAP

Answer 5

Generally Accepted Accounting Principles

Question 6

Asset Source

Answer 6

Increase total assets, Increase total claims

Ex. Borrowing cash from the bank

Question 7

Asset Exchange

Answer 7

Increase one asset, decrease another asset

Ex. Purchasing equipment with cash

Question 8

Asset Use

Answer 8

Decrease total assets, decrease total claims

Ex. Purchasing advertising expense with cash

Question 9

Operating Activities

Answer 9

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.

Question 10

Financing Activities

Answer 10

Transactions with creditors or investors used to fund either company operations or expansions (and dividends).

Question 11

Investing Activities

Answer 11

Consist of buying and selling long-term assets and other investments.

Question 12

Accrual Accounting

Answer 12

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.

Question 13

Accrual

Answer 13

Describes a revenue or an expense event that is recognized (or recorded) before cash is exchanged.

Question 14

Deferral

Answer 14

Describes a revenue or an expense event that is recognized (or recorded) after cash has been exchanged.

Question 15

The Accounting Cycle

Answer 15

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.

Question 16

Steps in an Accounting Cycle

Answer 16

Record transactions, adjust accounts, prepare statements, close nominal accounts

Question 17

Matching Concept

Answer 17

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.

Question 18

The Closing Process

Answer 18

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.

Question 19

Temporary Accounts

Answer 19

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.

Question 20

Temporary Accounts

Answer 20

Expenses, Revenues, Dividends

Question 21

Permanent Accounts

Answer 21

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

Question 22

Permanent Accounts

Answer 22

Liabilities, Assets, Equity

Question 23

Merchandising Businesses

Answer 23

Generate revenue by selling goods. The goods purchased for resale are called merchandise inventory.

Question 24

Product Costs

Answer 24

Costs that are included in inventory

Question 25

Period Costs

Answer 25

Costs that are not included in inventory. They are sometimes called Selling and Admin Costs.

Question 26

Costs of Goods Available for Sale

Answer 26

Beginning Inventory balance + Inventory during the purchase Merchandise inventory (balance sheet) Costs of goods sold (Income statement)

Question 27

Matching Principle

Answer 27

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.

Question 28

Gross Margin (or Gross Profit)

Answer 28

First section on an income statement for a merchandising company Sales revenue – Cost of goods = Gross Margin

Question 29

Perpetual Inventory System

Answer 29

Inventory account is adjusted perpetually (continually) throughout the accounting period Inventory increased for each item purchased Inventory decreased for each item sold

Question 30

Cash Discounts

Answer 30

A deduction from the invoice price granted to induce early payment of the amount due.

Question 31

FOB Shipping Point

Answer 31

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.

Question 32

FOB Destination

Answer 32

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.

Question 33

Shrinkage

Answer 33

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.

Question 34

Sales Discounts

Answer 34

Price reductions offered by sellers to encourage buyers to pay promptly.

Question 35

Sales Returns

Answer 35

Inventory returned by customers.

Question 36

Sales Allowances

Answer 36

Refers to reduction in the selling price when a customer agrees to accept a defective unit instead of returning it to the seller.

Question 37

Income statement for Merchandising Business

Answer 37

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.

Question 38

Operating Income

Answer 38

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.

Question 39

Purpose of Internal Control Systems

Answer 39

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.

Question 40

An Integrated Framework

Answer 40

1. Control Environment- Integrity and ethical values of a company 2. Risk Assessment- Management identification of potential risks 3. Control Activities- Internal controls 4. Information and Communication- Internal and external reporting process 5. Monitoring- Over time assessment and correction of internal controls

Question 41

Internal Controls

Answer 41

1. Separation of Duties 2. Quality of Employees 3. Bonded Employees 4. Required Absences 5. Procedures Manual 6. Authority and Responsibility 7. Prenumbered Documents 8. Physical Control 9. Performance Evaluations 10. Limitations

Question 42

Controlling Cash

Answer 42

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.

Question 43

Reconciling the Bank Account

Answer 43

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.

Question 44

Correction of Errors

Answer 44

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.

Question 45

Certified Check

Answer 45

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.

Question 46

The Fraud Triangle

Answer 46

Pressure, Opportunity, Rationalization

Question 47

Pressure

Answer 47

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.

Question 48

Opportunity

Answer 48

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.

Question 49

Rationalization

Answer 49

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”

Question 50

Fraud Red Flags

Answer 50

* 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