Accounting 101 Final Study guide

Know the 3 forms of business entities
Sole proprietorship- A single owner
Partnership- has two or more parties as co-owners each is an owner
Corporation- Owned by stockholders, or shareholders, who own stock representing share of ownership in the corporation.

Definition of Revenues
Increase in retained earnings from delivering goods or services to customers or clients.

Definition of Expenses
Decrease in retained earnings that results from operations; the cost of doing business

Internal Users
Users of accounting information are those individuals directly involved in managing and operating the organization

External Users
Users of accounting information are NOT directly involved in running the organization

FASB – responsible for GAAP (accounting principles)
Financial Accounting Standards Board -set accounting standards

Accounting Equation
Assets=Liabilities + Stockholder’s equity

Know the 3 activities that business engage in and give examples of each activity.
Financing: creates revenues, stocks

Investing: increase/decrease long-term activities, plants equipment

Operating: loans, pay dividends, repurchase its own stock, selling

The International Accounting Standards Board is responsible for developing a single set of worldwide accountings standards (IFRS)

These standards will help companies to reduce accounting costs, make it easier to acquire foreign companies, and facilitate comparisons between foreign companies.
IFRS- International Accounting Standards Board

Know the primary objective of financial reporting
Provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decision.

What makes information relevant?
Comparability, verifiability, timeliness, and understandability.
It must be capable of making a difference to the decision maker, having predictive or confirming value. It must be material, which means it must be important enough to the informed user.

Financial information should be understandable to whom
Existing and potential investors, lenders and other creditors, those willing to spend the necessary time to understand it.

Balance Sheet
lists assets, liabilities and owners’ equity
Tells what obligations will be due in the future

Income Statement
revenues minus expenses equal net income
Summarizes results, operations for a period of time

Net Income =
Revenues – Expenses
Single most important item on financial statement

Assets are recorded at historical/original cost because
it is objective and verifiable

Review various source documents. Source documents indicate a transaction has occurred. Ex: Invoice, check, time card, shipping/receiving documents.
A piece of paper that has been used to record a transaction

Owner invests in business
Cash increases, Stockholders equity (common stock) increases

Purchases supplies for cash
Cash Decreases, Supplies increase

Purchase supplies on account
Supplies increase, Accounts payable (liabilities) increases

Earn a revenue and receive a promise of cash at a later date
Accounts receivable increases, retained earnings increase

Left Side

Right Side

Initial recording of transaction is made in a journal/general journal (called journal entry, journalizing).
The entry is then posted to ledger/general ledger.

Know what is meant by a double-entry accounting system
Accounting records the dual effects on the entity. Each transaction affects at least two accounts.
You give something, you receive something in return.

What is the purpose of a trial balance?
A trial balance lists all accounts with their balances, assets first, then liabilities and stockholders’ equity.
Shows whether total debits equal total credits.

Accounts Receivable
Money owed to a business by its clients (customers or debtors) and shown on its balance sheet as an asset

Accounts Payable
Money owed by a business to its suppliers shown as a liability on a company’s balance sheet

When is revenue recognized with respect to accrual accounting?
When cash is earned

When is revenue recognized with respect to cash basis accounting?
When cash is received

When are adjusting entries required?
The end of the account period. When the accounts on the trial balance need to be brought up to date

Debit – Supplies Expense
Credit – Supplies (Revenue)
To record supplies for the month.

Unearned Revenues/Advance Payments
Debit – Advance Payments Receivables(unearned service revenue)
Credit – Advance Payments Revenues (Service revenue)
To record unearned revenues but not yet received.

Debit – Depreciation Expense
Credit – Accumulated Depreciation
To record depreciation for the month.

Accrued Salaries and wages
Debit -Wage and Salary Expense
Credit – Wages and Salary Payable
To record wages and salaries owed.

Closing entries: Revenue and expense accounts are closed to Retained Earnings at the end of the year.
They balance back to zero at the end of the year

What is a cash equivalent?
Investments such as time deposits, certificates of deposit, or high-grade government securities that are considered so similar to cash that they are combines with cash for financial disclosure purposes on the balance sheet.

Which asset is most liquid?

Deposits in transit
Add to Bank Statement

Outstanding Checks
Subtract from Bank Statement

Service Charges
Subtract from books

Interest Earned
Add to books

Add to Bank Statement

Review controls over cash, especially for cash sales
-Segregation of duties
-Proper authorization
-Adequate documents and records
-Physical controls

Can a foolproof Internal Control system be designed?

What accounting function can be performed only by a CPA?
Auditing Functions

Know and explain credit terms – i.e. 2/10, n/30
2/10: 2 percent cash discount pay within 10 days

n/10: Entire balance is due within 30 days

FOB shipping point
Require the buyer to pay for the shipping costs

FOB destination point
Require the seller to pay for the costs of shipping for
merchandise to the buyer

Who owns the inventory when it is in transit?
Shipping is buyer
Destination is shipper

Accounts Receivable
Short-term, within the current cycle. Sale with a verbal promise to pay

Notes Receivable
Long-term, past the current cycle. Liability resulting from the signing of a promissory note

2 methods for accounting for Bad Debts
Direct Write off method, and Allowance Method

Calculate Net Realizable Value of Accounts Receivable
=Accounts receivable – allowance for uncollectible accounts (bad debts)

Calculate interest for notes receivable
Principal*Annual interest rate*time period =interest

Gross Profit=
Sales – Cost of goods sold

Notes to Financial Statements
provide full disclosure

Example of the matching principle
Inventory is an asset/current asset. When inventory is sold, it becomes an expense (cost of goods sold).

Multiple-step Income Statement (which includes Gross Profit) is generally used by
merchandisers and retailers

What is indicated by the inventory turnover ratio?
Cost of goods sold
Measures the number of times a company sells its inventory during the year. How rapidly inventory is sold

First in first out

Last in Last out

Weighted Average
Same Unit cost to all units available

Specific Identification
Matching unit cost with the actual units sold

If FIFO is used ending inventory =
Newest inventory remains

If LIFO is used ending inventory =
Oldest inventory remains

Who would use Specific Identification?
Jewelers, auto sales, real estate, antiques

Explain Lower of Cost or Market
Based on the principles of relevance and representational faithfulness. LCM requires that inventory be reported in the financial statements at whichever is lower-the inventory’s historical cost or its market value.
The business reports ending inventory at its LCM value on the balance sheet.

Book value of an asset =
Cost minus Accumulated Depreciation

Which property, plant, and equipment asset is not depreciated?

In order to calculate depreciation, what three items need to be known?
Cost, estimated useful life, estimated residual value

The process of allocating the cost of a long-term tangible asset over its useful life

The process of allocating the cost of a limited life or intangible asset over its useful life

Single line=
(cost-residual value)/useful life, in years

Units of production=
(cost-residual value)/useful life, in units of production

Double Declining=
(1/useful life, in years) x 2

Figure gain/loss
(difference between BV and amount realized)

What is a parent
An investor with 50% or more in another company, investor

What is a subsidiary
The investee

Know definition of current liability and give examples
An obligation that will be satisfied within the next operating cycle or within one year if the cycle is shorter than a year
Known Amounts: Accounts payable, short-term notes payable, unearned revenues, accrued expenses

Current ratio =
current assets divided by current liabilities

Know what a contingent liability is and give examples
Contingent liability: A potential loss that may occur at some point in the future. Examples: outcome of a lawsuit, tax disputes, alleged violations of environmental protection laws

Know definition of long-term liability and give examples
Obligations that are net satisfied within 1 year. Leases, bonds

Callable Bonds
Bonds that may be redeemed or retired before their specified due date

Convertible bonds
Bonds that can be converted into common stock at a future time

Debenture bond
Unsecured bond-bonds backed only by the good faith of the borrower

Premium Bond
A bond issued at a price above its face (par) value

Discount Bond
A bond issued at a price below its face (par) value

Discount on Bonds Payable is what type of account?
Contra liability account

What is a capital lease? What is recorded in the accounting records for a capital lease?
Capital lease: long-term noncancelable debt.

The rights of the considered property should be recorded on the balance sheet.

Retained Earnings represent
Earnings that have not been distributed to stockholders

Par Value is
Face value. An arbitrary amount assigned by a company to a share of its stock

Why do investors purchase preferred stock?
They receive their dividends and assets before common stockholders

Know cumulative feature
The right to dividends in arrears before the current-year dividend is distributed

If $1 par value stock is sold for $20, by what amount is Cash increased, by what amount is Common Stock increased, and by what amount is Additional Paid-in Capital increased
Cash is increased – $20
Common Stock increased – $1
Additional Paid-in Capital increased -$19

Treasury Stock
A company’s own stock that it has issued and later reacquired

Why would corporations buy Treasury Stock
-Has issued all it’s authorized stocks and needs some stock for distribution
-Business wants to increase net assets by buying its stock low and hoping to resell it for higher price.
-Avoid a take over by an outside party

How is Treasury Stock recorded
Contra account decreases Stockholder’s equity

A company must have __________ and __________ to pay dividends.
Must have enough cash to pay the dividend and enough retained earnings to declare the dividend.

Two important dates for dividends are
Declaration Date: Dividends are declared

Payment Date: Payment of dividends

Know effect of stock dividend
Stock dividends increase the stock account and decreases Retained Earnings

Know effect of stock split
An increase in the number of authorized, issued, and outstanding shares of stock coupled with a proportionate reduction in the stock’s par value

Net Income =
Revenues – Expenses

What is the purpose of the Statement of Cash Flows?
Show where cash came from (receipts) and where it was spent (payments)

Indirect Method
Reconciles from net income to net cash provided by operating activities

Direct Method
Reports all cash receipts and cash payments from operating activities

Liquidity is
Measure of how quickly an item can be converted to cash

Profitability is
How well management is using company resources to earn a return on the funds invested by various groups

Working capital =
Current assets – Current liabilities

How are common-size income statements created?
Each item is expressed as a percentage of the revenue (net sale) amount
Divide everything by the net sale amount

Which ratio assesses capital structure and risk in a corporation?
Debt to Equity ratio = Total liabilities / Total Stockholders’ Equity

Inventory turnover
A measure of the number of times inventory is sold during a period.
Cost of goods sold/average inventory=Inventory turnover

Accounts receivable turnover
A measure of the number of times accounts receivables are collected in a period
Net sales/Average Net receivables= Accounts receivable turnover

Earnings per share (EPS)
Amount of a company’s net income earned for each share of its outstanding common stock
(Net income – Preferred Dividends)/Average # shares of common stock outstanding=EPS

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