Accounting in Business Chapter 1

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Questions and Answers

What impact do debits have on assets and expenses?

They increase both assets and expenses. (correct)

They decrease both assets and expenses.

They have no effect on assets or expenses.

They increase assets but decrease expenses.

What is the first step in the accounting cycle?

Identify and analyze the financial impact. (correct)

Journalize the transaction.

Prepare the unadjusted trial balance.

Post to the general ledger.

What is the primary purpose of a trial balance?

To list all assets and liabilities.

To prepare tax returns.

To determine the profit or loss for the period.

To ensure that total debits equal total credits. (correct)

What would a debt ratio of 0.4 indicate about a company?

40% of the company's assets are financed by debt. Signup and view all the answers

When posting a journal entry for a $5,000 credit sale, which account is debited?

Accounts Receivable. Signup and view all the answers

Which of the following represents a group of external users of accounting information?

Investors, creditors, government agencies Signup and view all the answers

According to the revenue recognition principle, when should revenue be recognized?

When it is earned, regardless of cash flow Signup and view all the answers

What does the cost principle dictate regarding asset reporting?

Assets must be recorded at their purchase cost Signup and view all the answers

How would paying $5,000 in dividends to shareholders affect the accounting equation?

Assets decrease, equity decreases Signup and view all the answers

Which of the following correctly describes the matching principle?

Revenue must be recognized in the same period expenses are incurred Signup and view all the answers

What role does ethics play in accounting?

Ethics ensure accuracy and transparency in financial information Signup and view all the answers

What is the impact on the accounting equation when a company purchases equipment on credit?

Assets increase and liabilities increase Signup and view all the answers

Which of the following describes the correct accounting treatment for a company that earns revenue but has not yet received cash?

Revenue is recognized once it is earned, even if cash hasn't been received Signup and view all the answers

What information does the Income Statement provide?

A report of revenues and expenses Signup and view all the answers

Which financial statement shows a company's assets, liabilities, and equity at a specific point in time?

Balance Sheet Signup and view all the answers

If a company has a net income of $50,000 and average total assets of $200,000, what is its Return on Assets (ROA)?

0.25 or 25% Signup and view all the answers

What role do source documents play in accounting?

They provide the basis for recording a transaction. Signup and view all the answers

When a company pays $1,000 in rent, which accounts are affected?

Debit Rent Expense, Credit Cash Signup and view all the answers

What does the General Journal primarily function as?

The first place where transactions are recorded Signup and view all the answers

In the context of accounting, what do liabilities include?

Accounts payable and notes payable Signup and view all the answers

How is the ending retained earnings calculated?

Starting Retained Earnings + Net Income - Dividends Signup and view all the answers

Study Notes

Users of Accounting Information

External Users include investors, creditors, and government agencies evaluating a company's financial statements for decisions like loan approvals.
Internal Users consist of management, employees, and internal auditors who utilize financial reports to analyze departmental performance and budgetary decisions.

Generally Accepted Accounting Principles (GAAP)

Revenue Recognition Principle states revenue must be recognized when earned, not when cash is received; example: a $1,200 subscription recognizes $100 monthly, despite upfront cash.
Expense Recognition Principle (Matching) mandates matching expenses to the revenues generated within the same period; example: sales commissions related to December sales are recorded in December, regardless of payment timing.
Cost Principle requires assets to be recorded at purchase cost, not current market value; example: an equipment purchase for $50,000 remains valued at that cost on financial statements.

Role of Ethics in Accounting

Ethics ensure accuracy and transparency in financial reporting; unethical practices involve concealing losses to misrepresent profitability while ethical accountants disclose all financial realities.

Elements of the Accounting Equation

The fundamental equation is Assets = Liabilities + Equity; for instance, a company with $100,000 in assets, $60,000 in liabilities, and $40,000 in equity follows this principle.
Transaction Impact Example: Buys a $10,000 machine on credit increases assets (Equipment +$10,000) and liabilities (Accounts Payable +$10,000).

Analyzing Business Transactions

Payment of $5,000 in dividends leads to a decrease in assets (Cash -$5,000) and a corresponding decrease in equity (Retained earnings -$5,000).

4 Financial Statements

Income Statement reflects revenues and expenses over a period, showing net income; e.g., $50,000 in revenues against $30,000 in expenses yields $20,000 net income.
Statement of Retained Earnings illustrates changes in retained earnings; starting with $10,000, adding $20,000 net income, and subtracting $5,000 in dividends results in $25,000.
Balance Sheet lists assets, liabilities, and equity at a specific date, e.g., $100,000 in assets, $40,000 in liabilities, and $60,000 in equity.
Statement of Cash Flows summarizes cash inflows and outflows; e.g., $10,000 cash inflows from operations, $3,000 cash outflows for investing.

Ratio – Return on Assets (ROA)

ROA is calculated as Net Income / Average Total Assets; example: net income of $50,000 with average total assets of $200,000 yields an ROA of 25%, indicating profit generation efficiency.

Source Documents

Source documents like sales receipts validate transactions; e.g., a $500 receipt records a sale in company accounts.

Role of Accounts

Assets include Cash, Accounts Receivable, and Equipment; liabilities include Accounts Payable and Notes Payable; equity includes Common Stock and Retained Earnings; examples of expenses are Rent Expense and Salaries Expense.
When paying rent of $1,000, Rent Expense is debited, increasing the expense account, while Cash is credited, decreasing the asset account.

General Journal and General Ledger

General Journal is where initial transactions are recorded; for instance, purchasing supplies on credit is noted as Debit Supplies and Credit Accounts Payable.
General Ledger organizes all accounts and their balances; increases in supplies and accounts payable are posted here.

Debits and Credits – Double-Entry Accounting

Debits increase assets and expenses; credits increase liabilities, equity, and revenues; e.g., receiving $1,000 cash for services involves debiting Cash and crediting Service Revenue.

Accounting Cycle – First 4 Steps

Identify and Analyze financial events; Journalize recorded transactions; Post to General Ledger; Prepare Unadjusted Trial Balance to ensure debits equal credits.

Purpose of a Trial Balance

A trial balance checks that total debits equal total credits and is essential for preparing accurate financial statements.

Journal Entries and Ledger Posting

Example of a journal entry for a $5,000 credit sale includes debiting Accounts Receivable and crediting Sales Revenue, both of which are subsequently posted to the general ledger.

Ratio – Debt Ratio

Debt Ratio is calculated as Total Liabilities / Total Assets; example: $40,000 in liabilities against $100,000 in assets equals a 40% debt ratio, indicating financial leverage risk.

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Description

Explore the foundational concepts of accounting as they relate to business in this quiz. Test your understanding of external and internal users of accounting information, as well as Generally Accepted Accounting Principles (GAAP) and their significance in financial reporting. Ideal for students studying accounting fundamentals.