Chapter 1: The Financial Statements – Flashcards
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Definition of Accounting
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In an information system that measures, processes and communicates financial information about a company to users.
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Purpose of Accounting
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-To provide useful information to users when making economic decisions -Accounting is the language of business
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Primary users of accounting information
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-Creditors (bankers) present and potential -investors present and potential -management -others (i.e. government, employees, financial advisors, etc.) ---All are concerned about profitability and liquidity (does the company have the ability to play in its debt)
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Areas in the Accounting Discipline
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-Financial accounting: published financial statements (our emphasis) -Management and cost accounting: budgeting, breakeven analysis, accounting systems, etc. -Tax accounting -Auditing: 1. Internal- accountant is employee of the company, 2. External- CPA examines a company's records and financial statements. -Government and non-for-profit -accounting systems
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Financial Accounting
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Provides information for EXTERNAL users (investors, bankers, government agencies)
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Management Accounting
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Provides information for INTERNAL users (managers of the company)
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What are the forms of business organization?
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-Proprietorship -Partnership -Corporation -Limited-Liability company
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Proprietorship
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-Business has a single owner -Legally, business is not separate from owner (owner is personally liable for business debts) -for accounting, business records are kept separate from personal records
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Partnership
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-two or more owners -each partner is personally liable for business debts (can be risky)
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Limited Liability Companies (LLC)
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-Owners are called members -Members are not personally liable for business debts (reduces owners risk) -Today, many non-corporate business form as LLC's
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Corporations
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-Owners are stockholders (stockholders elect board of directors- board sets policy and appoint officers; stock holders not personally liable for corporate debts) -formed under state law (pay income taxes) -Legally distinct from owners
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Separate Entity Concept
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-The company is distinct from the owners -Not concerned about the personal wealth of the owners
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Generally accepted accounting principles (GAAP)
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-Are accounting rules and methods that are required or allowed in preparing EXTERNAL financial statements -The financial accounting standards board is the current rule-making body
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Monetary Principle
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-Business transactions are measured in dollar terms (money measure) -We assume all dollars have the same purchasing power -Exchange rates involve the measure of one currency in terms of another
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Cost Principle
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-The records are maintained in terms of purchase price -If the market value of an asset changes this is NOT reflected in the financial statements
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Revenue
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-Amount charged to customers for goods and services (i.e sales, rent earned, fees earned, fares earned, interest earned, etc.) -are inflows of resources that increase retained earnings by delivering goods or services to customers -Example: A Gap store's sale of a pair of jeans brings in revenue and increases The Gap Incs. retained earnings
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Expenses
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-goods and services CONSUMED in operations -are resource outflows that decrease retained earnings due to operations -Represents the cost of doing business; they are the opposite of revenues -Example: the wages that The Gap Inc. pays employees is an expense and decrease retained earnings -Include: cost of goods sold, building rent, salaries, and utility payments; expenses also include the depreciation of display cases, racks, shelving and other equipment.
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Net Income=
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revenues-expenses
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Net Loss
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Results when expenses exceed revenues
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Assets
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-Are economic resources owned by the business -Have economic service potential and value -economic resources that are expected to produce a benefit in the future -i.e. Cash, accounts receivable, inventory, supplies, prepaid expenses,land, building and equipment, Merchandise inventory, note receivable
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Equities
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-Are claims to the assets -Two types: 1. Liabilities (or debt)- amounts owed to creditors (i.e. accounts payable, salaries payable, taxes payable, interest payable, unearned revenue, notes payable, bonds, payable, mortgage payable) 2. Owners equity- called stockholder equity (S/E) and it has two parts: A. Contributed Capital or Paid in Capital (Common stock; amounts invested by stockholders) B. Retained Earnings (increased by revenues; decreased by by expenses and dividends-cash paid to shareholders)
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Dividends
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-Distributions of assets (usually cash) to shareholders -Decrease retained earnings, because they are distributions to stockholders of assets (usually cash) generated by net income. -Remember: Dividends are not expenses. They never affect net income. Instead of being subtracted from revenues to compute net income, dividends are recorded as direct reductions of retained earnings.
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Only equation in accouting
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Assets = Liabilities + Stockholders Equity
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4 Financial Statements
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1. Income Statement: is a summary of revenues less expenses for the ENTIRE period; reports revenues and expenses for the period. (page 15) (Example: How well did the company perform during the year? Answer: Revenues-Expenses= Net income (or Net Loss) 2. Statement of Retained Earnings: Summarizes the changes in retained earnings for the ENTIRE period (retained earnings is increased by net income and decreased by dividends and net losses) (page 26-27) (Example: Why did the company's retained earnings change during the year? Answer: Beginning retained earnings + net income (or - Net loss) - Dividends = Ending retained earnings) 3. Balance Sheet or Statement of Financial Position: Lists the assets, liabilities, and owners equity as one specific day (page 27 and 17) (Example: What is the company's financial position at December 31? Answer: Assets= liabilities + Owners' Equity) 4. Statement of Cash Flows: Shows cash provided by operating, investing, and financing activities(page 27) (Example: How much cash did the company generate and spend during the year? Answer: Operating cash flows +/- investing cash flows +/- Financing cash flows = Increase (decrease) in cash)
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Bookkeeping
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-Not the same as accounting -is a mechanical part of accounting
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The overall objective of accounting is to....
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provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity.
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Fundamental Qualitative Characteristics
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-Relevance (includes materiality) -Faithful representation
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Enhancing Qualitative Characteristics
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-Comparability -Verifiability -Timeliness -Understandability
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A primary constraint in the decision to disclose accounting information is that....
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The COST of disclosure should not exceed the expected benefits to users.
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When total revenues exceed total expenses, the result is called
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net income, net earnings, or net profit
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When expenses exceed revenues, the result is a
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net loss
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If the beginning balance of retained earnings is $150,000, revenue is $75,000, expenses total $35,000 and the company declares and pays $10,000 dividend, what is the ending balance of retained earnings?
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$180,000 [$150,000 beginning balance + net income $40,000 ($75,000-$35,000) - dividends $10,000]
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All of the following statements are true except one, which one is false? A. A proprietorship is a business with several owners. B. Bookkeeping is only a part of accounting C. Professional accountants are held to a high standard of ethical conduct D. The organization that formulates generally accepted accounting principles in the United States is the Financial Accounting Standards Board
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A. A proprietorship is a business with several owners. Why? A proprietorship is a business with a single owner.
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The valuation of assets on the balance sheet is generally based on... A. selling price B. What it would cost to replace the asset C. current fair market value as established by independent appraisers D. historical cost.
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D. Historical Cost
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The Accounting equation can be expressed as A. Assets + Liabilities = Owners' Equity B. Owners' Equity - Assets = Liabilities C. Assets - Liabilities = Owners' Equity D. Assets = Liabilities - Owners' Equity
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C. Assets - Liabilities= Owners' Equity This is not the typical way the accounting equation is expressed (assets = liabilities + owners' equity), but it may be arranged this way.
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The nature of an asset is best described as A. something owned by a business that has a ready market value B. an economic resource that's expected to benefit future operations C. something with physical form that's valued at cost in the accounting records D. an economic resource representing cash or the right to receive cash in the future
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B. an economic resource that's expected to benefit future operations
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Which financial statement covers a period of time? A. Income statement B. Balance Sheet C. Statement of Cash Flows D. Both a and c
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D. Both a and c
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How would net income be most likely to affect the accounting equation? A. Increase assets and increase stockholders' equity B. Increase assets and increase liabilities C. Decrease assets and decrease liabilities D. Increase liabilities and decrease stockholders' equity
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A. Increase assets and increase stockholders' equity
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During the year, Aynsley Inc., has $280,000 revenues, $145,000 in expenses, and $6,000 in dividend declarations and payments. Stockholders' equity charged by A. +$135,000 B. +$129,000 C. -$129,000 D. +$141,000 Aynsley Inc. had.. A. net income of $129,000 B. net income of $135,000 C. net income of $141,000 D. net loss of $135,000
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B.+$129,000 ($280,000 - $145,000 - $6,000 = $129,000) B. net income of $135,000 ($280,000 - $145,000 = $135,000)
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Mighty Corporation hold cash of $8,000 and owes $31,000 on accounts payable. Might has accounts receivable of $47,000, inventory of $28,000, and land that cost $40,000. How much are Mighty's total assets and liabilities? A. Assets: $123,000 Liabilities: $31,000 B. Assets: $123,000 Liabilities: $59,000 C. Assets: $95,000 Liabilities: $59,000 D. Assets: $83,000 Liabilities: $71,000
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A. Assets: $123,000 Liabilities: $31,000 Total assets = 8,000 + $47,000 + 28,000 + 40,000 = $123,000 Total Liabilities = $31,000
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Which item(s) is (are) reported on the balance sheet? A. Retained earnings B. Inventory C. Accounts Payable D. All of the Above
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D. All of the above
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During the year, Romero Company's stockholders' equity increased from $98,000 to $116,000. Romero earned net income of $25,000. Assume no changes in the capital stock accounts. How much in dividends did Romero declare during the year? A. $18,000 B. $7,000 C. $25,000 D. $0
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B. $7,000 $98,000 + Net income $25,000 - Dividends $7,000 = $116,000
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Parret Company had total assets of $175,000 and total stockholders equity of $78,000 at the beginning of the year. During the year, assets increased by $42,000 and liabilities increased by $12,000. Stockholders' equity at the end of the year is A. $108,000 B. $120,000 C. $132,000 D. $139,000
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A. $108,000 (page 52 for solving)
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Which of the following is a true statement about International Financial Reporting Standards? A. The are not needed for U.S. businesses since the United States already has the strongest accounting standards in the world. B. They are not being applied anywhere else in the yet, but soon they will be. C. They are converging gradually with U.S. standards. D. They are more exact (contain more rules) than U.S. generally accepted accounting principles
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C. The are converging gradually with U.S. standards
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Which of the following is the most accurate statement regarding ethics as applied to decision making in accounting? A. Ethics involves making difficult choices under pressure and should be kept in mind in making every decision, including those involving accounting. B. It is impossible to learn ethical decision making, since it is just something you decide to do or not to do. C. Ethics has no place in accounting, since accounting deals purely with numbers D. Ethics is becoming less and less important as a field of study in business
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A. Ethics involves making difficult choices under pressure and should be kept in mind in making every decision, including those involving accounting.
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Classify the following as an Asset, a Liability, or Stockholders Equity: 1. Accounts receivable 2. Long-Term debt 3. Merchandise Inventory 4. Prepaid expense 5. Accrued Expenses Payable 6. Equipment 7. Notes Payable 8. Retained Earnings 9. Land 10. Accounts payable 11. Common stock 12. Supplies 13. Unearned revenue
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1. Asset 2. Liability 3. Stockholders' Equity 4. Asset 5. Liability 6. Asset 7. Liability 8. Stockholders' Equity 9. Asset 10. Liability 11. Stockholders' Equity 12. Asset 13. Liability
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Identify the financial statement where the decision makers can find the information. A. Revenue B. Dividends C. Ending Cash Balance D. Total Assets E. Selling, general, and administrative expense F. Adjustments to reconcile net income to net cash provided by operations G. Cash spent to acquire the building H. Current Liabilities I. Income tax Expense J. Net income K. Common stock L. Ending balance of retained earnings M. Income tax payable N. Long-term debt
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A. Income Statement B. Statement of Retained Earnings C. Cash Flows, Balance Sheet D. Balance Sheet E. Income Statement F. Cash Flows G. Balance Sheet, Cash Flows H. Balance Sheet I. Income Statement J. Income Statement, Retained Earnings, Cash Flows K. Balance Sheet L. Statement of Retained Earnings, Balance Sheet M. Balance Sheet N. Balance Sheet
