Financial Accounting Unit 1

Front 1

accounting

Back 1

A system of maintaining records of a company's operations and communicating that information to decision makers.

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net income

Back 2

A measurement of the difference between revenues and expenses. No other single piece of company information better explains a company's stock price performance than this value; literally, the "bottom line" on the income statement.

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long-term assets

Back 3

Resources owned by a company that are thought to provide benefits for more than 1 year.

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stockholders' equity

Back 4

Stockholders' (investors') claims to a corporation's resources; the difference between the amount the company owns and the amount it owes, i.e., the value of the firm to its owners. The value is found by subtracting liabilities from assests or by adding together common stock and retained earnings.

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basic accounting equation

Back 5

Assets = Liabilities + Stockholders' Equity
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After each transaction this equation must ALWAYS remain in balance, so resources (assets) must always equal claims to resources (liabilities and stockholders' equity); in other words, "what you OWN is equal to what you OWE."

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assets

Back 6

Resources owned by a company, i.e., cash, inventory, land/buildings, equipment/machines, materials/supplies, etc.

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liabilities

Back 7

Amounts owed that must be paid by a specific date. For example, outstanding loans, taxes, utility payments, unpaid wages, etc. In the accounting equation, equal to assets minus stockholders' equity. A company's debt level is a key indicator of managerial ability and the possibility of bankruptcy.

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common stock

Back 8

Amounts invested by stockholders (owners of the corporation) when they purchase shares of stock; an external source of stockholders' equity.

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retained earnings

Back 9

The cumuluative amount of net income, earned over the life of the company, that has NOT been distributed to stockholders as dividends; an internal source of stockholders equity.
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Revenues - Expenses - Dividends = _____________

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account

Back 10

A summary of the effects of all transactions related to a particular item over a period of time.

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expenses

Back 11

The costs of providing products and services. An increase in these costs decreases stockholders' equity. Expenses are increased with a debit and decreased with a credit.

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net profit

Back 12

A positive net income; occurs when the difference between revenues and expenses is a positive number, i.e., revenues are greater than expenses.

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net loss

Back 13

A negative net income; occurs when the difference between revenues and expenses is negative, i.e., when expenses are greater than revenues.

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debit and credit effects on accounts

Back 14

In the basic accounting equation:
* An asset account will normally have a debit balance.
*A liability account will normally have a credit balance.
*A stockholder's equity account will normally have a credit balance.

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credit

Back 15

1) Means "right."
2) On the left (assets) side of the accounting equation, this is a decrease; on the right (liabilities) side of the equation, this is an increase.
3) In a T-account, it is recorded in the right column.

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debit

Back 16

1) Means "left."
2) On the left (assets) side of the accounting equation, this is an increase; on the right (liabilities) side of the equation, this is a decrease.
3) In a T-account, it is recorded in the left column.

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T-account

Back 17

A simplified representation of an account in the shape of the letter "T." Across the top is the account title, and on the two sides we record debits and credits on the left and right, respectively.

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effect of dividends on net income and stockholders' equity

Back 18

An increase in dividends decreases retained equity, thereby decreasing stockholders' equity. Dividends are a distribution of net income and therefore have no effect on the net income amount.

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effect of revenues on net income and stockholders' equity

Back 19

An increase in revenues causes net income to increase, which increases retained earnings, thus increasing stockholders' equity.

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effect of expenses on net income and stockholders' equity

Back 20

An increase in expenses decreases net income, which decreases retained earnings and thus decreases stockholders' equity.

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unearned revenue

Back 21

Cash received in advance from customers as payment for goods/services to be provided at a future date; considered a debt and thus recorded as a liability until goods/services are provided.

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accounts receivable

Back 22

Services or goods provided to a customer on account or "credit" extended; account that tracks the amounts owed to a firm.

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measuring external transactions

Back 23

The foundation of financial accounting, a 6-step process that involves:
1) Using source documents to identify accounts affected by an external transaction.
2) Analyzing the transaction's impact on the accounting equation.
3) Assessing whether the result is a debit or credit to the account balance.
4) Recording the transaction.
5) Posting the transaction to a T-account in the general ledger.
6) Preparing a trial balance.

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fundamental model of business valuation

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The value of a company to its owners equals the total resources of the company minus the amounts owed to creditors. Creditors expect to receive only resources equal to the amount owed them; stockholders, on the other hand, can claim all resources in excess of the amount owed to creditors.

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statement of stockholders' equity

Back 25

A financial statement that summarizes the changes in stockholders' equity over an interval of time; the 2 primary components are common stock and retained earnings. It reports information related to changes in common stock and retained earnings each period.
****
Net Income - Dividends = ^Retained Earnings

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accounts payable

Back 26

Liabilities incurred by a firm for items purchased on account with a promise to pay at a future date.

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prepaid assets

Back 27

Expenses that are paid in advance and are recorded as assets until the time they are actually incurred, i.e., rent paid for the whole year, bi-annual insurance or quarterly advertising payments.

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dual effect of a transaction

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If an economic event increases/decreases one side of the equation, then it also increases/decreases the other side of the equation by the same amount. At least 2 accounts will be affected by every transaction or economic event; for example, an investment by an owner of $25k gets recorded under "assets" as an increase in cash AND under "stockholders' equity" as an increase in common stock.

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order of business activities

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For a new company:
1) Obtain external financing.
2) Invest in long-term productive assets.
3) Begin normal operations.

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external transactions

Back 30

Transactions conducted between a firm and separate economic entities, i.e., selling products to customers, paying salaries to emplyees, purchasing supplies from a vender, or borrowing money from a bank.

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internal transactions

Back 31

Events that affect the financial position of the company but do not include a separate economic entity, i.e., using supplies on hand, receiving cash in advance from a customer.

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source documents

Back 32

Receipts, invoices, bills from suppliers, and signed contracts that provide information related to external transactions; usually identifies the date and nature of a transaction, participating parties, and monetary details.

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chart of accounts

Back 33

A list of all account names used to record transactions of a company.

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investors and creditors

Back 34

The 2 primary external users of financial accounting information. Investors and creditors want to know about the company's resources and their claims to those resources.

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income statement

Back 35

Financial statement that reports the company's revenues and expenses over an interval of time; it compares revenues and expenses for the current period to assess the company's ability to ear a profit from running its operations. The 3 major headings include "revenues," "expenses," and "net income."

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net change in cash

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The total of the net cash flows from operating, investing, and financing activities during the statement period.

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balance sheet

Back 37

Financial statement that represents the financial position of the company on a particular date, summarized by the basic accounting equation. It demonstrates that the company's resources (assets) equal creditors' claims (liabilities) plus owners' claims (stockholders' equity). The ending balance is equal to the statement of cash flow balance.

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determinants of success

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SUCCESSFUL COMPANIES use their resources efficiently to sell products and services at a competitive price while making a profit.
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UNSUCCESSFUL COMPANIES either offer lower quality products and services or do not efficiently keep their costs low and so are not profitable.

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roles of accounting

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1) Measurement: To create a record of the financing, investing, and operating activities of the company.
2) Communication: To communicate information about the financing, investing, and operating activities of the company via financial reporting.

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sources of financial accounting information

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Publicly traded firms are required to report:
* The 4 primary financial statements.
* Management discussion and analysis
* Note disclosures

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management discussion and analysis

Back 41

One of the elements of mandatory reporting, includes management's views on significant events, trends, and uncertainities pertaining to the company's operations and resources.

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note disclosures

Back 42

One of the elements of mandatory reporting, includes additional information that either explains the financial statements or provides information not included on the financial statements.

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relationships between financial statements

Back 43

1) The amount of net income on the ncome statement appears on the statement of stockholders' equity.
2) The ending balance in the statement of stockholders' equity appears on the balance sheet.
3) The amount of cash in the balance sheet appears as the ending cash balance in the statement of cash flows.

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primary financial statements

Back 44

One of the elements of mandatory reporting, includes:
* Income Statement
* Balance Sheet
* Statement of Stockholders' Equity
* Statement of Cash Flows

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statement of cash flows

Back 45

A financial statement that measures activities involving cash receipts and cash payments over an interval of time; it reports cash transactions from operating, investing, and financing activities. An important source of information to investors and creditors, includes cash infows, cash outflows, and net cash flows. The ending balance is the same as the balance sheet.

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financing cash flows

Back 46

Cash transactions with lenders (such as borrowing/repaying money) and with stockholders' (issuing stock and paying dividends).

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investing cash flows

Back 47

Generally includes cash transactions for the purchase and sale of investments and productive long-term assets.

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operating cash flows

Back 48

cash receipts and cash payments for transactions involving revenues and expenses.

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"payables"

Back 49

Term used to identify liabilities as accounts to be paid.

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limited liability

Back 50

stockholders are not held personally responsible for the financial obligations of the corporation; stockholders can lose no more than their investment.

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corporation

Back 51

A group of people (stockholders) authorized to act as a single entity. Subject to higher taxation but benefit from limited liability.

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sole proprietorship

Back 52

A business owned by one person; owner is personally liable for company's debts.

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partnership

Back 53

A business owned by 2 or more people; owners are personally liable for the company's debts.

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measurement categories

Back 54

Assets, liabilities, and stockholders' equity; revenues and expenses.

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operating activities

Back 55

Transactions/decisions that relate to the primary operations of the company, such as providing products and services to customers and the associated costs of doing so (utilities, wages, rent, taxes, advertising, maintenance, etc.); measurement categories include revenues and expenses.

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investing activities

Back 56

Transactions/decisions relating to the purchase and sale of long-term resources such as land, buildings, equipment/machinery, and any resources not directly related to the primary operations of a company; measurement category is assets.

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financing activities

Back 57

Transactions/decisions involving external sources of funding, such as borrowing, sales/issuance of stock, and payment of dividends; measurement categories include liabilities and stockholders' equity. The 2 basic sources of external funding are creditors and investors.

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managerial accounting

Back 58

Accounting methods used to provide information to an organization's internal users, i.e., its own managers.

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generally accepted accounting principles (GAAP)

Back 59

The rules that all companies that sell their stock publicly must follow and publish their financial statements in accordance with, allowing users to accurately compare financial information among companies when making lending or investing decisions; established primarily by the FASB.

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Financial Accounting Standards Board (FASB)

Back 60

An independent private-sector body with full-time voting members (including representatives from the accounting profession, large corporations, financial analysts, accounting educators, and government agencies) whose primary function is to establish financial accounting and reporting standards (GAAP).

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International Accounting Standards Board (IASB)

Back 61

A global standard-setting body whose objectives are to develop a single set of high-quality global accounting standards, to promote the use of those standards, and to foster a global convergence of national and international accounting standards (as per the Norwalk Agreement of 2002).

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"cooking the books"

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Providing false and/or misleading financial information on financial statements; for example, in order to hide poor operating performance of the company or to embezzle money from stockholders.

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Securities & Exchange Commission (SEC)

Back 63

Government agency created by the Securities Exchange Act of 1934 to enforce and set accounting standards. It has the power to overrule the FASB and requires independent outside verification of the financial statements of all publicly traded companies.

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auditors

Back 64

People hired by a company as an independent party to evaluate the company's financial statements and express a professional opinion as to their accuracy. They play a major role in investor/creditor decisions by adding credibility to a company's financial statements. They are NOT employed by the companies who hire them.

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financial accounting

Back 65

Accounting methods used to measure the business activities of a company and communicate those measurements to external parties for decision-making purposes. Provides information essential to making good business decisions; i.e., predicts cash flows, tells about economic resources, claims to resources, and changes in resources and claims.

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ethics

Back 66

A code or moral system that provides criteria for evaluating right and wrong behavior.

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Sarbanes-Oxley Act (SOX)

Back 67

Act of Congress passed in 2002 that provides for the regulation of auditors and the types of services they provide, increases corporate executive accountability, addresses conflicts of interest for securities analysts, and provides stiff criminal penalties for violators.

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framework for approaching ethical dilemmas

Back 68

1) Identify the ethical situation and the people who will be affected.
2) Specify the options for alternative courses of action.
3) Understand the impact of each option on the stakeholders.
4) Make a decision.

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"Big 4"

Back 69

The 4 largest public accounting firms; Deloitte, Ernst & Young, Price Waterhouse Coopers, and KPMG. These companies audit almost all of the Fortune 500 companies in the U.S. and most of the largest companies around the world.

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public accounting firms

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Professional service firms that traditionally have focused on auditing, tax preparation/planning, and business consulting; accountants must be licensed.

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private accountants

Back 71

People who provide accounting services to the company that employs them, typically does not require licensure.

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FASB's conceptual framework

Back 72

The "theory" of accounting; provides the underlying foundation for the development of accounting standards and interpretation of accounting information, and outlines the 3 objectives of financial accounting.

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neutrality

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To be unbiased. If a new accounting standard favors one group, the FASB must demonstrate its ________, proving this is a consequence of the standard rather than an objective of the standard.

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primary qualitative characteristics

Back 74

To be useful for decision making, accounting information should have:
1) Relevance: Information posesses confirmatory value and/or predictive value.
2) Faithful representation: Accounting information should be complete, neutral, and free from material error. (Completeness means all information necessary for faithful representation, as well as adequate note disclosure, is included.)

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freedom from material error

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Indicates that reported amounts reflect the best available information.

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enhancing qualitative characteristics

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1) Comparability.
2) Verifiability.
3) Timeliness.
4) Understandability.

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comparability

Back 77

The ability of users to see similarities and differences between 2 different business activities, as well as within the same company over time; achieved via consistency.

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verifiability

Back 78

Implies a consensus among different measures.

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timeliness

Back 79

Information is available to users early enough to be used in the decision process.

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understandability

Back 80

Users must be able to understand the information within the context of the decision being made; user-specific quality.

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practical constraints on qualitative characteristics

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1) Cost effectiveness: Suggests that financial accounting information is provided only when the benefits of doing so exceed the costs.
2) Materiality: Unless an item is material in amount or nature (i.e., sufficient in amount or nature to affect a decision), it need not be reported, in accordance with GAAP.

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assumptions underlying GAAP

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1) Economic entity assumption.
2) Monetary unit assumption.
3) Periodicity assumption.
4) The going concern assumption.

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economic entity assumption

Back 83

The assumption that we should identify all economic events with respect to a particular economic entity (i.e., only business transactions that INVOLVE a company should be reported by said company). A key aspect is the distinction between the economic activities of the owners and those of the company.

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monetary unit assumption

Back 84

The assumption that in order to measure financial statement elements we need a unit or scale of measurement (i.e., the U.S. dollar).

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periodicity assumption

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The assumption that the economic life of an enterprise (presumed to be indefinite) is divided into artificial time periods for periodic financial reporting.

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going-concern assumption

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The assumption that in the absence of information to the contrary, a business entity will continue to operate indefinitely; provides justification for measuring many assets based on their original costs.

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principles underlying GAAP

Back 87

The principles that guide the application of GAAP, namely the:
* historical cost principle
* principle of full disclosure
* principle of realization
* matching principle

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functions of accounting

Back 88

The ______ __ _______ are to measure the activities of a company and communicate those measurements to users.

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financial statements

Back 89

Periodic reports published by the company for the purpose of providing information to external users. They give investors and creditors key information used in making financial decisions.

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stockholders

Back 90

The owners of a corporation.

Front 91

trial balance

Back 91

A list of all accounts and their balances at a particular date, showing that debits equal total credits (note that just because debits equal credits, it does not mean that all account balances are correct). Assists us in preparing financial statements and in preparing adjusting entries.

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order of accounts in trial balance

Back 92

1) assets
2) liabilities
3) stockholders' equity
4) dividends
5) revenues
6) expenses

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posting

Back 93

The process of transferring the debit and credit information from transactions recorded in the journal to the T-accounts in the general ledger. When finished, the sum of the accounts with debit balances should equal the sum of the accounts with credit balances.

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general ledger

Back 94

Includes all accounts used to record the company's transactions. All transactions are posted here. Format includes an account title, account number, date, and columns for increass, decreases, and cumulative balance. Each account is a collection of all transactions that affect that account. The sum of accounts with debit balances should equal the sum of accounts with credit balances.

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journal entry

Back 95

Every entry has at least one credit and one debit. The format for recording a transaction in a journal includes the transaction date, account names, debit and credit amounts, and a description. The credit account information is always listed below the debit information and indented. For example,
*****
01/01/13 Debit Credit
Cash $25,000
Common Stock $25,000
(Issue common stock for cash.)

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journal

Back 96

A chronological record of all transactions (journal entries) affecting a firm.

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dividends

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Cash payments made to stockholders, usually every 3 months. These payments are based upon a company's profits and therefore are not guaranteed. These payments are NOT considered an expense, they are a distribution of net income. An increase in these payments decreases stockholders' equity.

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revenues

Back 98

The amounts earned from selling products or services to customers. An increase in these amounts increases stockholders' equity. We increase revenues with a credit and decrease revenues with a debit.

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important equations

Back 99

* Assets = Liabilities + Stockholders' Equity
* Stockholders' Equity = Common Stock + Retained Earnings
* Retained Earnings = Revenues - Expenses - Dividends

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asset accounts

Back 100

An account that includes information about a resource owned by the company, normally will have a debit balance. Examples are cash, equipment, supplies, and accounts receivable.

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stockholders' equity accounts

Back 101

Accounts that include information about owners' claims to company resources, usually has a credit balance. Examples are common stock, revenues, dividends, retained earnings, and expenses.

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liability accounts

Back 102

Accounts that include information about a company's debts, normally will have a credit balance. Examples include accounts payable, utilities payable, salaries payable, and notes payable.

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DEALOR

Back 103

Dividends Liabilities
Expenses Owners' Equity
Assets Revenues
DEBIT = INCREASE DEBIT = DECREASE
CREDIT = DECREASE CREDIT = INCREASE