Accounting 211 Exam 1 Fundamental Accounting Principles Wild Shaw Chiapetta

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2 Types of Users of accounting information

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Internal and External Users

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What is an Internal User?

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Users from inside the business.

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What are the 3 types of Internal Users?

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Managerial Accountants
1. Owners of Business
- Owners, Partners, Shareholders
2. Managers of business
- decision makers, CFO, CEO, COO
3. Employees of business

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What is an External User?

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Individuals from outside the business.

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Types of External Users?

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Financial Accountants, potential investors, tax authorities, regulatory authorities (such as the securities and exchange commission), suppliers, customers, bankers, competitors

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What does GAAP stand for?

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Generally Accepted Accounting Principles

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Generally Accepted Accounting Principles

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GAAP - is a term used to refer to the standard framework of guidelines for financial accounting used in any given jurisdiction; generally known as Accounting Standards. GAAP includes the standards, conventions, and rules accountants follow in recording and summarizing transactions, and in the preparation of financial statements.

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What is the Accounting Equation?

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Assets = Liabilities + Equity (Owners Equity)

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What are assets?

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Economic assets are entities functioning as a store of value over which ownership rights are enforced by institutional units, individually or collectively, and from which economic benefits may be derived by their owners by holding them or using them over a period of time.

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Types of assets?

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Cash and cash equivalents,
Short term investments
Debtors/Accounts Receivable
Stocks & Bonds
Long-Term Assets or Fixed Assets
tangible or intangible
cash, accounts receivables, equipment, automobiles

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What does liquidity mean?

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how fast an asset can be converted into cash. Assets are listed in order of ________. Cash 1st always

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What are capital assets?

(also called plant assets)

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as permanent things your company owns. Land, buildings, equipment and vehicles are common capital assets. So are things like computers, furniture and appliances, as long as they remain for use within your business and are not items you sell.

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What is an intangible asset?

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Patents, copyrights and other non-material assets that have value are referred to as intangible.

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What is a liability?

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Anything a company owes to people or businesses other than its owners is considered a liability. There are two types of liabilities:

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What are the two types of liabilities?

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Current liabilities and
Long Term Liabilities

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Current Liabilities?

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Current liabilities. In general, if a liability must be paid within a year, it is considered current. This includes bills, money you owe to your vendors and suppliers, employee payroll and short-term loans.

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Long Term Liabilities?

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Long-term liabilities. A long-term liability is any debt that extends beyond one year, such as a mortgage.

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Another word for Owners Equity?

What is Owners Equity?

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Capital

any debt owed to the business owners,
outstanding preferred and common stock, At the end of each accounting cycle, a business' profits get transferred to a capital account.initial and subsequent investments,

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Owner Equity Accounts?

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Capital Account - The companies net worth. Initial and subsequent Investments are recorded here as well as changes in the equity of the owners; such as net income or loss. Capital stock represents the investment of stockholders for corporations, and retained earnings represents the net income/loss.

Drawing Account - Also known as the Personal Account, this account is used to record withdrawals from the company by the owner or owners.

Revenue Accounts - The gross increases to owner's equity. Sources include sales of merchandise or services, rental properties, lending money, commissions, and other income generating ventures.

Expense Accounts - The costs incurred during the day to day operation of the business are expenses. Examples include, Salary Expense, Supplies Expense, Utilities Expense, and Rent Expense..

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4 Types of Financial Statements?

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1. Income Statement
2. Owners Equity Statements (Reatined earnings statements)
3. Balance Sheets
4. Statement of Cash Flow

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Income Statement

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The income statement is the first of the financial statements to be created. The income statement lists all of a company's revenues and expenses as it relates to income-generating activities. The revenues would be the sales that the company generates. The expenses would cover various operating items, such as the cost of inventory, utilities and rent related to the company's working space, and advertising expenses, among others. The end result of the income statement allows you to see the net income of the company, which you can analyze against the firm's sales, debt and expenses if desired.

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Balance Sheet

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The Balance sheet, generated after the income statement, will list all of the assets, liabilities, and equity of the company.

A company's assets generally include cash on hand, accounts receivable, inventory, and long-term assets such as equipment, land, or property.

A company's liabilities generally refer to the short -term debt and normal operating expenses, such as the bills paid each month by the company or amounts payable from operating or financing activities.

A company's equity is characterized as the amount the can be converted to ownership of the company in question, and what the approximate value of that equity would be. Larger companies may also issue a statement of shareholders' equity to break down the types of financing done.

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Statement of Cash Flow

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The final main financial statement generated is the Cash Flow statement. This document details all of the company's activities that are related to cash inflow or outlays. The cash flow statement breaks down these types of activities in three groups.

Operating activities are transactions that affect the everyday operations of the company, such as the purchase of inventory to generate revenue or payroll expenses.

Investing activities involve the addition of long-term assets which are not necessarily charged as expenses, such as the purchase of equipment or investments in other companies.

Financing activities involve the receipt of cash in exchange for bonds or other long-term holdings of the company, such as the issuance of stock.

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Statement of Owners Equity

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The statement of owners equity is the second report of the financial statements. Its full name is the statement of changes in the owners equity.

This accounting report shows all the changes to the owners equity that have occurred during the period. These changes comprise capital, drawings and the profit for the period.

Just like the income statement, this statement normally covers a twelve-month period.

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How to prepare financial statements?

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Every quarter, a company must create financial statements regarding its business activities. These statements must give an informed view into the operations of the company and the overall financial health of the company. The company must follow certain procedures in accounting for its operations, investments and financing activities. Every transaction should be accounted in developing a company's financial statements.

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What goes on the Income Statements?

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Revenue-Expenses=Net Income

Income, sales etc.

Subtract all expenses (list them all in order from greatest to least, with the exception of misc. expenses which always goes last)

Then you're left with NIBT, which is net income before taxes.

All income (sales) and expenses (cost of goods sold, payroll, rent, depreciation, etc.). It helps me to remember that it is also called a "profit and loss statement."

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What goes on the Statement of the Owners Equity?

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Capital

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What goes on the Balance Sheet?

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???

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What goes on the Statement of Cash Flow?

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???

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accounting

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is an information and measurement system that identifies, records and communicates relevant, reliable, and comparable information about an organizations business activities.

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internal reports

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not subject to same rules as external reports. They are designed with special needs of external users in mind.

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GAAP

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concepts and rules that govern financial accounting. Purpose of GAAP is to make information in accounting statements relevant, reliable and comparable.

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In U.S. major rule-setting bodies

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are the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB).

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The International Accounting Standards Board (IASB)

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issues standards that identifies preferred accounting practices in the global economy and hopes to create harmony among accounting practices in different countries.

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2 types of Principles and Assumptions of Accounting

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two types are

general (basic assumptions, concepts and guidelines for preparing financial statements; stem from long used accounting practices)

and specific (detailed rules used in reporting transactions; from rulings of authoritative bodies).

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The four principles discussed in this chapter are:

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Cost Principle
Revenue Recognition Principle
Matching Principle
Full Disclosure Principle

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Cost Principle

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financial statements are based on actual costs incurred in business transactions. Cost is measured on a cash or equal-to-cash basis. This principle emphasizes reliability and verifiability, and information based on cost considered objective. Objectivity means information is supported by unbiased evidence: more than someone's opinion.

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Revenue Recognition Principle

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revenue is recognized (recorded) when earned. Proceeds need not be in cash. Revenue is measured by cash received plus the cash value of other items received.

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Matching principle

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a company must record expenses incurred to generate revenues it reported.

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Full disclosure principle

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requires reporting the details behind the financial statements that would impacts users’ decisions.

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The four assumptions discussed in this chapter are:

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Going-concern assumption
Monetary unit assumption
Time period assumption
Business entity assumption

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Going-concern assumption

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accounting information reflects the assumption that the business will continue operating instead of being closed or sold.

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Monetary unit assumption

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transactions and events are expressed in monetary, or money, units. Generally this is the currency of the country in which it operates but today some companies express reports in more than one monetary unit.

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Time period assumption

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the life of the company can be divided into time periods, such as months and years, and that useful reports can be prepared for those periods.

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Business entity assumption

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a business is accounted for separate from other business entities and separate from its owner.

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Types of Business Entities

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Sole proprietorship
Partnership

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Sole proprietorship

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is a business owned by one person that has unlimited liability. The business is not subject to an income tax but the owner is responsible for personal income tax on the net income of entity.

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Partnership

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is a business owned by two or more people, called partners, who are subject to unlimited liability. The business is not subject to an income tax, but the owners are responsible for personal income tax on their individual share of the net income of entity.

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Three special partnership forms that limit liability?

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Limited partnership (LP)
Limited liability partnership (LLP) Limited liability company (LLC)

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Limited partnership (LP)

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has a general partner(s) with unlimited liability and a limited partner(s) with limited liability restricted to the amount invested.

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Limited liability partnership (LLP)

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restricts partner’s liabilities to their own acts and the acts of individuals under their control.

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Limited liability company (LLC

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offers the limited liability of a corporation and the tax treatment of a partnership.

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Corporation

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is a business that is a separate legal entity whose owners are called shareholders or stockholders. These owners have limited liability. The entity is responsible for a business income tax and the owners are responsible for personal income tax on profits that are distributed to them in the form of dividends.

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Sarbanes-Oxley (SOX)

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Law passed by congress that requires public companies to apply both accounting oversight and stringent internal controls to achieve more transparency, accountability and truthfulness in reporting.

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Accounting equation

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Assets = Liabilities + Equity

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Accounting equation elements of the equation include:

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1. Assets
2. Liabilities
3. Equity

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Assets

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resources owned or controlled by a company that are expected to yield future benefit. (i.e. cash, supplies, equipment and land)

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Liabilities

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creditors’ claims on assets. These claims reflect obligations to transfer assets or provide products or services to others.

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Equity

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owner’s claim on assets. Also called net assets or residual equity.

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Changes in Equity result from...

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investments, revenues, withdrawals, expenses.

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Investments

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assets an owner puts into the company results in an increase in equity. Recorded under the title Owner, Capital.

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Revenues

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gross increases in equity resulting from a company’s earning activities.

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Owner’s withdrawals

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assets an owner takes from the company for personal use (results in decrease in equity).

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Expenses

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cost of assets or services used to earn revenues (results in decrease in equity).

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Expanded Accounting Equation:

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Assets = Liabilities + Owner’s Capital – Owner’s Withdrawal + Revenues – Expenses

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Transaction Analysis

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each transaction and event always leaves the equation in balance.

(Assets = Liabilities + Equity)

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1.Investment by owner =

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Investment by owner =
+Asset (Cash) = + Owner’s Equity (Owner’s Name, Capital)
reason: investment
Increase on both sides of equation keeps equation in balance

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2.Purchase supplies for cash =

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Purchase supplies for cash =
+Asset (Supplies) = – Asset (Cash)

Increase and decrease on one side of the equation keeps the equation in balance.

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3.Purchase equipment for cash =

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Purchase equipment for cash =
+ Asset (Equipment) = – Asset (Cash)

Increase and decrease on one side of the equation keeps the equation in balance.

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4.Purchase supplies on credit =
+ Asset (Supplies) =

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Purchase supplies on credit =
+ Asset (Supplies) = + Liability (Account Payable)

Increase on both sides of equation keeps equation in balance.

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5.Provide services for cash =

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5.Provide services for cash =
+ Asset (Cash) = + Owner’s Equity (reason: revenue earned)

Increase on both sides of equation keeps equation in balance.

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6. Payment of expense in cash (salaries, rent etc.) =

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6.Payment of expense in cash (salaries, rent etc.) =
– Asset (Cash) = – Owner’s Equity (reason: expense incurred)

Decrease on both sides of equation keeps equation in balance.

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7.Provided services and facilities for credit =

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7.Provided services and facilities for credit =
+ Asset (Accts Receivable) = + O E (reason: revenue earned)

Increase on both sides of equation keeps equation in balance.

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8. Receipt of cash from account receivable =

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8. Receipt of cash from account receivable =
+ Asset (Cash) = – Asset (Accounts Receivable)

Increase and decrease on one side of the equation keeps the equation in balance.

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9. Payment of accounts payable =

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9. Payment of accounts payable =
–Asset (Cash) = – Liability (Accounts Payable)

Decrease on both sides of equation keeps equation in balance.

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10. Withdrawal of cash by owner =

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Withdrawal of cash by owner =
–Asset (Cash) = – Equity (reason: owner’s withdrawal)

Decrease on both sides of equation keeps equation in balance.(note: since withdrawals are not expenses they are not used in computing net income.)

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The four financial statements and their purposes are:

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Income Statement
Statement of Owner’s Equity
Balance Sheet
Statement of Cash Flows

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Income Statement

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describes a company’s revenues and expenses along with the resulting net income or loss over a period of time. (Net income occurs when revenues exceed expenses. Net loss occurs when expenses exceed revenues.)

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Statement of Owner’s Equity

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explains changes in equity from net income (or loss) and from owner investment and withdrawals over a period of time.

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Balance Sheet

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describes a company’s financial position (types and amounts of assets, liabilities, and equity) at a point in time.

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Statement of Cash Flows

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identifies cash inflows (receipts) and cash outflows (payments) over a period of time.

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Statement Preparation from Transaction Analysis

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prepared in the following order using the procedure indicated below.

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Income Statement

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information about revenues and expenses is conveniently taken from the owner's equity column. Total revenues minus total expenses equals net income or loss. Notice that owner’s withdrawals and investments are not part of measuring income or loss.

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Statement of Changes in Owner’s Equity

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the beginning owner’ equity is taken from the owner’s equity column and any investments of owner are added. The net income, from the income statement is added (or the net loss is subtracted) and finally the owner’s withdrawals are subtracted to arrive at the ending capital. Ending capital is carried to the Balance Sheet.

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Balance Sheet

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the ending balance of each asset is listed and the total of this listing equals total assets. The ending balance of each liability is listed and the total of this listing equals total liabilities. The ending capital (note that this is taken from the statement of changes in owner’s equity), is listed and added to total liabilities to get total liabilities and owner’s equity. This total must agree with total assets to prove the accounting equation. Either the account form or the report form may be used to prepare the balance sheet.

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Statement of Cash Flows

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the cash column must be carefully analyzed to organize and report cash flows in categories of operating, financing, and investing. The net change in cash is determined by combining the net cash flow in each of the three categories. This change is combined with the beginning cash. The resulting figure should be the ending cash that was shown on the balance sheet.

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Decision Analysis—Return on Assets (ROA)

Also called Return on Investment (ROI)

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a profitability measure.

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ROA or ROI?

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Useful in evaluating management, analyzing and forecasting profits, and planning activities.

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The return on assets is: calculated by

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dividing net income for a period by average total assets. (Average total assets is determined by adding the beginning and ending assets and dividing by 2.)

As with all analysis tools, results should be compared to previous business results as well as competitor’s results and industry norms.

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Risk and Return Analysis

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Risk—the uncertainty about the return we will earn on an investment.

The lower the risk, the lower the return.

Higher risk implies higher, but riskier implied returns.

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Business Activities and the Accounting Equation

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The accounting equation is derived from business activities.

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Three major business activities are:

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1. Financing activities
2.Investing activities
3.Operating activities

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Financing activities

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activities that provide the means organizations use to pay for resources such as land, buildings, and equipment to carry out plans.

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Two types of financing are:

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1. Owner financing
2. Non-owner (or creditor) financing

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Owner financing

Back 95

refers to resources contributed by owner including income left in the

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Nonowner (or creditor) financing

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refers to resources contributed by creditors (lenders).

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Investing activities

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are the acquiring and disposing of resources (assets) that an organization uses to acquire and sell its products or services.

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Operating activities

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involve using resources to research, develop, purchase, produce, distribute, and market products and services.

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Investing (assets)

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is balanced by Financing (liabilities and equity). Operating activities is the results of investing and financing.

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Basic Accounting Equation

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ASSETS = LIABILITIES + OWNER’S EQUITY

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TRANSACTION ANALYSIS RULES

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1. Every transaction affects at least two items.

2. Every transaction must result in a balanced equation.

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TRANSACTION ANALYSIS POSSIBILITIES:

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Assets = L + OE
(1) + and +
OR(2) - and -
OR(3) +/- and No change
OR(4)No change and + and -

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Ethics

Back 103

a key concept. Ethics are beliefs that distinguish right from wrong.

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Fundamentals of Accounting

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accounting is guided by principles, standards, concepts, and assumptions.

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Opportunities in Accounting

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1. Private accounting offers the most opportunities.
2. Public accounting offers the next largest number of opportunities
3. Government (and not-for-profit) agencies, including business regulation and investigation of law violations also offer opportunities.

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Four broad areas of opportunities are

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financial,
managerial,
taxation,
and accounting related.

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Managerial Accounting

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is the area of accounting that serves the decision-making needs of internal users.

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Internal Reports

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not subject to same rules as external reports. They are designed with special needs of external users in mind.

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Internal Information Users

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those directly involved in managing and operating an organization.

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Users of Accounting Information

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1. External Information Users
a. Financial Accounting
b. General-Purpose Financial Statement

2. Internal Information Users
a. Managerial Accounting
b. Internal Reports

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External Information Users

Back 111

those not directly involved with running the company. Examples: shareholders (investors), lenders, customers, suppliers, regulators, lawyers, brokers, the press etc.

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Financial Accounting

Back 112

area of accounting aimed at serving external users by providing them with general-purpose financial statements.

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General-Purpose Financial Statement

Back 113

statements that have broad range of purposes which external users rely on.

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Internal Information Users

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those directly involved in managing and operating an organization.

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Managerial Accounting

Back 115

is the area of accounting that serves the decision-making needs of internal users.

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Internal Reports

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not subject to same rules as external reports. They are designed with special needs of external users in mind.

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Importance of Accounting

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we live in the information age, where information, and its reliability, impacts the financial well-being of us all.

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Accounting Activities

Back 118

Accounting, Auditing,

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Accounting

Back 119

is an information and measurement system that identifies, records and communicates relevant, reliable, and comparable information about an organizations business activities.

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There are 5 basic Account Types:

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Assets
Liabilities
Equity
Revenue Expenses

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Assets

Back 121

something you own or have

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Liabilities

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something you owe to someone (payable in the future)

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Equity

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value of owner's investment

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Revenue

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value of goods delivered or services performed (key is if work has been completed not if we have been paid for it)

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Expenses

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costs of the company (again here, it doesn't matter if payment has been paid)

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If Total Assets are $500,000 and Equity is $320,000, how do you determine amount of Liabilities?

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Accounting Equation is
ASSETS = LIABILITIES + EQUITY.

It can also be written as:
ASSETS - EQUITY = LIABILITIES

Assets $500,000 - Equity $320,000
= $180,000 Liabilities