Exam 1 Study Guide - Introduction to Financial Accounting | ACCT 2001, Study notes of Financial Accounting

Download Exam 1 Study Guide - Introduction to Financial Accounting | ACCT 2001 and more Study notes Financial Accounting in PDF only on Docsity! Accounting Exam #1 Study Guide Chapter 1: Forms of Business Organization Sole Proprietorship: A business owned by one person. -Simple to set up -Gives you control -Tax advantages Partnership: A business owned by two or more persons. -Often formed because one individual is low on economic resources -Simple to establish -Shared control -Broader skills and resources -Tax advantages Corporation: A separate legal entity owned by stockholders. -Easier to transfer ownership -Easier to raise funds -No personal liability Users of Accounting Internal Users: Managers who plan, organize, and run a business. This includes marketing managers, production supervisors, finance directors, and company officers. Questions that must be answered: -Finance: Is cash sufficient to pay dividends to stockholders? -Marketing: What price for a product will maximize the company’s net income? -Human Resources: Can we afford to give our company employees pay raises this year? -Management: Which product line is most profitable? External Users: Types: -Investors (owners): Use accounting information to make decisions to buy, keep or sell stock. -Creditors (suppliers and bankers): Use accounting information to evaluate the risks of selling on credit or lending money. -Taxing Authorities (IRS): Use information to make sure that companies abide by tax laws. -Customers: Use information to ensure that companies honor product warranties. -Labor Unions (MLB): Want to know whether or not owners have the ability to pay increased wages and benefits. Regulatory Agencies (FTC): Ensure companies are operating within prescribed rules. Fin. Sarbanes-Oxley Act (2002): Passed by Congress to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals. Business Activities Financing: Using money to make money (borrowing money and selling stocks). Investing: Using cash raised through financing activities to make money. Involves purchasing resources, also known as assets. Operating: Using the assets needed to get started to operate and sell products. Used to make revenue: sales revenue, service revenue, and interest revenue. Recording Statements Income Statement: Reports the success or failure of the company’s operating activities for a period of time. 1) Revenues - 2) Expenses = 3) Net Income *Provides investors with useful information for predicting future net income. Creditors also use information to predict future earnings. *Amounts received from issuing stock are not revenues, and the amounts paid out as dividends are not expenses. Profitability Ratio: Measures the operating success of a company for a given period of time. Working Capital (Current Assets – Current Liabilities), when assets exceed liabilities, working capital is positive (higher chance of being able to pay creditors). Current Ratio (Liquidity)=Current Assets/Current Liabilities *Does not take into account the composition of current assets. Solvency: The ability for a company to repay debt as it matures. Solvency Ratios: Measure survivability over a long period of time. Securities and Exchange Commission (SEC): The agrency of the U.S. government that oversees U.S. financial markets and accounting standard-setting bodies. Financial Accounting Standards Board (FASB): The primary accounting standard-setting body in the U.S. International Accounting Standards Board (IASB): Issues standards called International Financial Reporting Standards (IFRS). Public Company Accounting Oversight Board (PCAOB): Determine auditing standards and review the performance of auditing firms. Relevance: Does it make a difference in a business decision? Faithful Representation: Does the information accurately depict what happened? Must be complete and neutral. Assumptions in Financial Reporting: Monetary Unit Assumption: Requires that only things that can be expressed in money are included in the accounting records. Economic Entity Assumption: States that every economic entity can be separately identified and accounted for. Periodicity Assumption: States that the life of a business can be divided into artificial time periods and that useful reports covering those periods can be prepared for a business. Going Concern Assumption: States that the business will remain in operation for the foreseeable future. Accrual Basis: Transactions that change a company’s financial statements are recorded in the periods in which the events occur. Accounting Principles: Cost Principle: Dictates that companies record assets at their cost. If the value of a purchased object fluctuates, the company still records the original cost. Fair Value Principle: Indicates that assets and liabilities should be reported at fair value (the price received to sell an asset or liability). Only applied where assets are actively traded. Full Disclosure: Requires that companies disclose all circumstances and events that would make a difference to financial statement users. Constraints in Financial Reporting: Materiality Constraint: A financial statement’s impact on a company’s overall financial condition and operations. Cost Constraint: Relates to the fact that providing information is costly. Chapter 3: Accounting Information System: The system of collecting and processing transaction data and communicating financial information to decision makers. Accounting Transactions: Economic events that require recording in the financial statements. *Dividends reduce stockholders’ equity but are not an expense. Steps in Recording Process: The Journal: Where transactions are recorded (in chronological order) before they are transferred to the accounts. Shows debit and credit effects on specific amounts. *Every company has a general journal which: discloses in one place the complete effect of a transaction, provides a chronological record of transactions, and helps to prevent or locate errors by comparing debit and credit amounts. Journalizing: The process of entering data in the journal. Ledger: The entire group of accounts maintained by a company. Keeps in one place all the information about changes in specific account balances. *Every company has a general ledger, which contains all the assets, liabilities, and stockholders’ equity, revenue, and expense accounts. Chart of Accounts: Records accounts. Posting: The procedure of transferring journal entry amounts to ledger accounts. Trial Balance: Lists accounts and their balances at a given time. Usually prepared at the end of an accounting period. Can help uncover errors in journalizing and posting. Chapter 4: Revenue Recognition Principle: Requires companies to recognize revenue in the accounting period in which it is earned. Accrual Versus Cash Basis of Accounting: Accrual-basis accounting: Means that transactions that change a company’s financial statements are recorded in the period in which the events occur. Useful Life: The life of assets such as buildings, equipment, and motor vehicles. Depreciation: Contra Asset Account. Accrued Revenues: Revenues earned but not yet recorded. Accrued Expenses: Expenses incurred but not paid or recorded at the statement date. Preparing Closing Entries: Income Summary: Used to close revenues and expenses. Post-closing Trial Balance: Comes after a company journalizes and posts all closing entries. Comes from the ledger.