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sole propietorship

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owned by one person; usually small, local businesses; easy to set up; owner is personally responsible for the business

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partnership

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owned jointly by 2+ individuals; access to skills of each of the partners; partners jointly responsible for the business; partnership is automatically dissolved when any partner leaves

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corporation

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organized under laws of a particular state; owned by stockholders; stockholders' legal responsibility is limited to the amount they invested in stock; higher income tax rate; double taxation

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financing activities

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obtaining funds necessary to begin and operate a business (by issuing stock or borrowing money)

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creditor

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a person to whom a corporation owes money

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liability

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the obligation to pay a creditor - can take form as notes payable (a promise to pay back the amount plus interest), bonds payable (special form of notes payable, large amounts of money), etc.

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dividends

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distributions of a company's earnings to stockholders

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assets

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economic resources (creditors and stockholders have a claim on assets)

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investing activities

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buying assets that allow a company to operate (land, machinery, equipment, etc.)

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revenue

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increase in assets that results from the sale of products/services

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expenses

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cost of assets used (liabilities created) in the operation of the business

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account payable

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purchasing goods on credit from a supplier

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wages payable

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amount owed to employees

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income taxes payable

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taxes owed to the government

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net income

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revenue greater than expenses (revenues - expenses)

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net loss

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expenses greater than revenue

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financial statements

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summarization and report of detailed transactions - helps investors and creditors make judgements to serve as the basis of their decision making

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balance sheet

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reports the resources (assets) owned by a company and the claims against those resources (liabilities and stockholders' equity) at a specific point in time

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income statement

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reports how well a company has performed its operations (revenues, expenses and income) over a period of time

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retained earnings statement

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reports how much of a company's income was retained in the business and how much was distributed to owners over a period of time

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statement of cash flows

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reports sources and uses of a company's cash over a period of time

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GAAP

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generally accepted accounting principles; rules to guide preparation of financial statements

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who creates GAAP?

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SEC has power to, but they delegate it to FASB, who works closely with IASB to develop international financial reporting standards

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fundamental accounting equation

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assets = liabilities + stockholders' equity

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classified balance sheet

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classified to help users identify the fundamental economic similarities/differences between the various items within the balance sheet; shows how a company obtained its resources and whether a company will be able to pay its obligations when they become due

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common balance sheet classifications

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assets: current assets, long-term investments, property, plant and equipment, intangible assets liabilities:current liabilities, long-term liabilities stockholders' equity: contributed capital, retained earnings

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current assets

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cash and other assets that are reasonably expected to be converted into cash within one year (or one operating cycle); common types of current assets: cash, short-term investments, accounts receivable, inventories

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long-term investments

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company expects to hold the investment for more than one year; can also include land/buildings that a company is not currently using in operations

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property, plant and equipment

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tangible, long-lived, productive assets used by a company in its operations

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intangible assets

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provide a benefit to a company over a number of years, but lack physical substance (i.e. patents, copyrights, trademarks, etc.)

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other noncurrent assets

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a catch-all category including items such as deferred charges and other long=term miscellaneous items

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current liabilities

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obligations that will be satisfied within one year or the operating cycle; typically listed in order of when they will be payed; includes: accounts payable, salaries payable, unearned revenue, interest payable and income taxes payable

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long-term liabilities

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obligations of company that require payment beyond one year (i.e. notes payable, bonds payable)

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stockholders' equity

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primarily arises from contributed capital and retained earnings

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capital

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combination of liabilities and equity

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liquidity

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ability to pay obligations as they become due, measured by working capital and current ratio

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working capital

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working capital = current assets-current liabilities, is useful when only looking at one company but not looking at multiple

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current ratio

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current ratio = current assets/current liabilities

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single step income statement

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only two categories: total revenues and total expenses (total expenses subtracted from total revenues in a single step to arrive at net income)

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multiple step income statement

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provides classifications of revenues and expenses with three subtotals: gross margin (net sales - cost of goods sold), income from operations (gross margin - operating expenses) and net income (income from operations - any nonoperating revenues/expenses)

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net profit margin

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sometimes called return on sales, shows percentage of profit in each dollar of sales revenue; net profit margin = net income/sales revenue

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cash flows

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3 categories: cash flows from operating activities (directly related to earning income; cash sales, collections as accounts receivable, etc.), cash flows from investing activities (related to acquisition/sale of investments and long-term assets such as property, plant and equipment), and cash flows from financing activities (related to obtaining capital of company; issuance and repayment of debt, common stock transactions, payment of dividends, etc.)

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annual report

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contained within a company's 10-K filing, includes financial statements and other important info such as notes to financial statements, management's discussion/analysis of condition of the company and auditor's report

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notes to the financial statements

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also called footnotes; clarify and expand upon the information presented in the financial statements

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auditor's report

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auditor's opinion of the financial statement

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qualitative characteristics

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fundamental: relevance, faithful representation enhancing: comparability, verifiability, timeliness, understandability

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relevance

answer

information is capable of making a difference in a business decision by helping users predict future events of providing feedback about prior expectations

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faithful representation

answer

complete, neutral and accurate information (includes all necessary information for the user to understand the economic event)

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comparability

answer

allows external users to identify similarities and differences between two or more items (consistency also applies)

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verifiability

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independent parties can agree on the measurement of the activity

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timeliness

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information is available to users before it loses its ability to influence decisions

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understandability

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users who have a reasonable knowledge of accounting and business can comprehend the information

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cost constraint

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the benefit received from accounting information should be greater than the cost of providing that information

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full disclosure

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any information that would make a difference to financial statement users should be revealed

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assumptions

answer

economic entity, continuity (going concern), time period, monetary unit

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economic entity assumption

answer

each company is accounted for separately from its owners (e.g. Bill Gates' personal transactions aren't recorded in Microsoft's financial statements)

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continuity assumption

answer

a company will continue to operate long enough to carry out its existing commitments

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time period assumption

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allows the life of a company to be divided into artificial time periods so net income can be measured for a specific period of time

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monetary unit assumption

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requires that a company account for and report its financial results in monetary terms

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principles

answer

historical cost, revenue recognition, expense recognition (matching), conservatism

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historical cost principle

answer

requires that the activities of a company are initially measured at their cost - the exchange price at the time the activity occurs

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revenue recognition principle

answer

used to determine when revenue is recorded and reported - revenue is to be recognized or recorded in the period in which it is earned and the collection of cash is reasonably assured

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expense recognition (or matching) principle

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requires that an expence be recorded and reported in the same period as the revenue that it helped generate (may/may not be the same period that cash is paid)

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conservatism principle

answer

accountants should take care to avoid assets or income when they prepare financial statements - conservatism is a prudent reaction to uncertainty and offsets management's natural optimism about the company's future prospects

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accounting cycle

answer

the sequence of procedures used by companies to transform the effects of business activities into financial statements (analyze transactions, journalize transactions, post to the ledger, prepare a trial balance, adjust the accounts, prepare financial statements, close the accounts)

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transaction analysis

answer

process of determining the economic effects of a transaction on the elements of the accounting equation; usually begins with gathering of source documents that describe business activities... steps of transaction analysis: write down the equation, identify the financial statement elements that are affected by the transaction, determine whether the elements increased or decreased

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double-entry accounting

answer

system used by companies to record the effects of transactions on the accounting equation (each transaction affects at least two accounts)

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account

answer

record of increases and decreases in each of the basic elements of the financial statements

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balance

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the amount in an account at any given time

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T-account

answer

account title, then debits on the left side and credits on the right side

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debit & credit procedures

answer

draw a t-account and label each side, determine the normal balance of an account, increases or decreases to an account are based on the normal balance of the account

Financial Accounting Ch. 1 and 2 Cornett – Flashcards

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