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What is the Accounting Equation?
Assets = Liabilities + Stockholder's Equity
What are the four types of transactions that affect equity?
- Owner Investments
- Owner Withdrawals
How are Assets listed?
In order of liquidity
How are Liabilities listed?
In order of maturity.
Increases in equity as a result of operations of a business (sales).
Decreases in equity (resources used up to help earn revenues).
What are the four financial statements and in what order are they prepared?
- Income Statement (Revenues - Expenses = Net Income/Loss)
- Statement of Owner's Equity (SE +/- Net Income = Balance)
- Balance Sheet (Assets = Liabilities + SE)
- Statement of Cash Flows
What is GAAP and who is responsible for developing the accounting standards?
Generally Accepted Accounting Principles developed to provide guidelines for financial accounting practices. Currently FASB (Financial Accounting Standards Board) has responsibility for developing accounting standards.
Name the 5 organizations that influence current accounting practice.
- FASB: Financial Accounting Standards Board (establishes GAAP today)
- SEC: Securities & Exchange Commission (determines financial statement rules for public companies)
- PCAOB: Public Company Accounting Oversight Board (auditing standards)
- AICPA: American Institute of CPAs (Pro association of CPAs)
- IASC: International Accounting Standards Board (developing international accounting standards)
What are the four Principles of Accounting? Explain each.
- Historical Cost: the amount paid (or exchanged) on the transaction date is used to initially record the elements.
- Revenue Recognition: record revenue only when it is measurable, realizable or realized, and earned.
- Matching Principle: records the expenses when the expense is incurred to generate revenues.
- Full Disclosure: must provide users with information that could impact a decision.
What are the four Assumptions? Explain each.
- Unit of Measure: measurements are in monetary units ($$)
- Separate Entity: activities of a business are separate and distinct from its owners
- Periodicity (time period): financial life of a company can be reported in shorter time periods (usually month end, quarter end & year end)
- Continuity (going concern): entity will not be going out of business in the near future
What are the four Characteristics of Useful Information?
- Relevant: Info provided would impact decision
- Reliable: Can be independently verified to be accurate
- Comparable: Similar accounting methods have been applied accross different companies
- Consistent: Within a company, similar accounting methods have been applied over time
What are the four Constraints? Explain each.
- Cost/Benefit: benefits to providing the information to the users should outweigh the costs to provide it.
- Materiality: determination that relatively small amounts (if omitted or recorded incorrectly) would not affect or impact a decision.
- Industry Practices: acceptable industry specific practices that deviate from the normal GAAP principles.
- Conservatism: when alternative accounting valuations can be used, the amount that is least likely to overstate assets and/or revenues, or to understate liabilities and/or expenses should be used.
What are the steps in the Accounting Cycle?
- 1) Analyze the transaction: Determine the affects of the transaction and what accounts are affected.
- 2) Apply the rules of double entry (debits=credits)
- 3) Record the entry in the general journal. The general journal is a chronological listing (date order) of each transaction, and what accounts are debited and credited.
- 4) Post the entry to the general ledger (T-accounts)
- 5) At each month end, subtotal each account (called "footing the accounts") and prepare a trial balance to make sure all debits=credits.
- 6) Prepare adjusting entries to ensure proper revenue recognition & matching.
- 7) Prepare an adjusted trial balance to ensure all debits=credits.
- 8) Prepare financial statements: Income Statement, Statement of Retained Earnings, Balance Sheet & Statement of Cash Flows.
- 9) At year-end, prepare closing entries to close all income statement accounts (called nominal accounts) into retained earnings (or owner's equity account).
What is the Financial Leverage Ration equation and what do the results gauge?
Financial Leverage Ratio= Avg Ttl Assets [(BB+EB)/2] / Avg Stockholder's Equity [(BB+EB)/2]
- 1.0 means no debt financing
- 2.0 means an equal amount of debt and equity financing
- above 2.0 means more debt is being used to finance than equity
How is Earnings per Share calculated?
EPS= Net Income/Avg. # of Common Shares Outstanding
What are the two types of Adjusting Entries for Revenues?
- Unearned Revenues (Deferral) : previously recorded liability that was created when cash was received in advance of performing a service (earning the revenue). Amounts must be adjusted for amount of revenue that has now been earned during the period.
- [Debit: Unearned revenues Credit: Revenues] *Got cash early now need to do work
- Accrued Revenues (Accrual) : revenues that have been previously earned but have not yet been recorded.
- [Debit: Accounts Receivable Credit: Revenues] *Did the work now need to get paid
What are the two types of Adjusting Entries for Expenses?
- Prepaid Expenses (Deferral) : Previously recorded assets that were paid for in advance but must be adjusted for the amount of expense that has been incurred during the period. (Amount used up ie. Supplies)
- [Debit: Supplies Expense Credit: Prepaid Supplies] *Paid for early now used up incrementally
- Accrued Expenses (Accrual) : Expenses that have been incurred but have not been recorded or paid.
- [Debit: Expense Credit: Accrued Payable] *Got the Service - pay later
What is the ALWAYS & the NEVER with reference to Adjusting Entries?
They will ALWAYS effect 1 Balance Sheet account & 1 Income Statement account.
They will NEVER be Cash.
What is the equation to calculate Net Profit Margin?
Net Profit Margin= Net Income/ New Sales (Revenues)
What are the three steps to approaching Error Corrections?
- 1) "Did" : Determine what entry was booked
- 2) "S/H/D" : Determine what entry Should Have been Done had it been recorded correctly
- 3) "Fix" : Determine what entry is necessary in order to fix the error