BA211Z Midterm Skills List and Study Aid PDF

BA211Z Midterm Skills List and Study Aid Chapters 1-5 SKILLS LIST Chapter 1: - Recognize business activities measured by financial accounting - Describe the role of financial accounting in decision making - Understand the four key financial statements and related information Chapter 2:...

BA211Z Midterm Skills List and Study Aid Chapters 1-5 SKILLS LIST Chapter 1: - Recognize business activities measured by financial accounting - Describe the role of financial accounting in decision making - Understand the four key financial statements and related information Chapter 2: - Describe the various asset classifications and measurement methods. - Describe the various liability and stockholders’ equity classifications. - Describe revenues, expenses, gains, and losses. - Calculate the different measures of income. - Identify operating, investing, and financing cash flows. - Understand the purpose of the statement of stockholders’ equity. Chapter 3: - Analyze the effects of transactions on assets, liabilities, and stockholders’ equity - Analyze the effects of transactions on revenues, expenses, and dividends - Prepare a trial balance - Prepare a preliminary balance sheet and income statement Chapter 4: - Understand when asset, liabilities, revenues, and expenses are recorded - Distinguish between accrual-basis and cash-basis accounting - Adjust account balances at the end of the period - Calculate adjusted balances of all accounts - Prepare financial statements using the adjusted account balances - Close temporary account balances Chapter 5: - Revenue Recognition o Explain when revenue should be recognized at a single point in time. o Explain when revenue should be recognized over a period of time. o Calculate net revenues using sales returns and sales discounts. - Accounts Receivable Recognition and Valuation o Recognize accounts receivable at the time of credit sales. o Establish an allowance for uncollectible accounts. o Write off accounts receivable as uncollectible. STUDY AID Chapter 1: Financial Accounting Overview All business activities can be categorized into one of three types:  Operating: primary operations of the company  Investing: purchase and sale of resources that are expected to benefit the company for many years  Financing: transactions with investors (stock) and creditors (debt) From a legal perspective companies select a corporate form. Publicly traded companies will always be Corporations, and for the purpose of this class we will focus on that structure which has shareholders (stockholders) who own the corporation, and the entity pays taxes as a stand-alone organization separate from its owners.  A corporation is a company that is legally separate from its owners. o Advantage: Stockholders have limited liability.  Other forms: o A sole proprietorship is a business owned by one person. o A partnership is a business owned by two or more persons.  Both have a Disadvantage: No limitation on liability. From a financial perspective, transactions are recorded and financial information is tracked and reported using a fundamental business valuation concept called the Accounting Equation:  Assets = total resources of the company  Liabilities = amounts owed to creditors  Stockholders’ equity = owners’ claims to resources Financial statements are periodic reports published by the company for the purpose of providing information to external users. Balance sheet Income statement Statement of stockholders’ equity Statement of cash flows Business activities are measured in certain ways (the following shows the linkage between measurement and the accounting equation): Financial information is summarized and reported using a standard set of “Financial Statements”, the four core parts are:  BALANCE SHEET – reports the financial position at a point in time (a specific date: i.e. 12/31/2022)  INCOME STATEMENT – reports the revenues & expenses during the accounting period (a period of time: i.e. For the year ended 12/31/2022)  STATEMENT OF STOCKHOLDERS’ EQUITY – reports the changes in each of the company’s stockholders’ equity accounts during the accounting period (a period of time: i.e. For the year ended 12/31/2022)  STATEMENT OF CASH FLOWS – reports inflows and outflows of cash during the accounting period (a period of time: i.e. For the year ended 12/31/2022) Financial statements are followed by detailed notes that provide more information to the reader of the financial statements. Common elements on a balance sheet include: An income statement (also called a Profit and Loss statement or Statement of Operations) shows: Common elements on an income statement include: Common elements on a statement of stockholders equity include: The fourth statement, the Statement of Cash Flows, shows the transactions of a business in the three categories of: Operating, Investing and Financing. Chapter 2: Financial Reporting and Financial Statement Attributes GAAP: In the United States the set of rules that govern how companies report financial information are called Generally Accepted Accounting Principles (GAAP):  GAAP is set by the Financial Accounting Standards Board (FASB)  FASB is given its authority by the Securities and Exchange Commission (SEC)  SEC enforces GAAP for publicly traded companies in the US Attributes of Financial Statements: Each financial statement has certain attributes to it that help the reader (investor) understand the position and performance of a company. Balance sheets have:  Reports a company’s financial position at a point in time  Organized list of assets, liabilities, and equity  Grouped by common characteristics  Considers the operating cycle of the company (typically 1 year), which results in Assets and Liabilities being segregated into Current and Long-Term (Noncurrent) categories: Assets, which are listed in order of liquidity, starting with the most liquid (cash), the distinction between Current and Long-Term is: Assets are measured (value) at one of four methods depending on the type of asset as prescribed by GAAP:  Historical cost – based on their original transaction value  Amortized cost- historical cost of an asset adjusted for the depreciation or amortization accumulated over its lifetime  Net realizable value – net amount of cash which an asset could be converted in the ordinary course of business  Fair value- price that would be received to sell assets in an orderly transaction between market participants on a given date (market or present) Liabilities, which are listed in order of maturity, starting with the one with the shortest maturity (typically accounts payable):  Represent obligations to others (entities, suppliers, employees, customers, lenders, etc.  Classified into two major categories: o Current liabilities – due within one year, examples include:  Accounts Payable - Obligations to suppliers of merchandise or services purchased on account (payment usually due in 30 to 60 days)  Deferred Revenues - Represent cash received from a customer for goods or service to be provided in a future period  Accrued Liabilities - Represent obligations created when expenses have been incurred but not yet paid (i.e. accrued salaries payable, accrued interest payable) o Long-term liabilities – are due in more than one year, examples include:  Note – long-term loan in which the company is the borrower  Bond – formal debt security issued by the company to a debt market  Lease – a financial obligation arising from an arrangement between two parties for the right to use an asset for a specified period of time  Pension obligation – estimated financial commitment related to retirement benefits o Some long-term liabilities have a current portion due in the coming year  Example: A $1,000,000 note payable requiring $100,000 in principal payments to be made in each of the next 10 years Stockholders’ equity is simply total assets minus total liabilities: Assets − Liabili es = Stockholders’ Equity. And is sometimes referred to as net assets or book value. Equity arises primarily from two sources:  Contributed capital (comes from external parties) o Common stock o Additional paid-in capital  Retained earnings (generated by the company) Income statement measures activity over a period of time. It reports a company’s profit (or loss) during a particular period; generally, one year or one quarter. The primary elements are: There multiple sub-totals in a multi-step income that measure results (profit or loss) at different levels:  Gross profit – equals sales revenues – cost of goods sold  Operating income – includes gross profit less additional expenses related to the operating activities of the company  Nonoperating income – includes revenues, expenses, gains, and losses related to investing and financing activities  Pre-tax income – the sum of operating income and nonoperating income  Net income – total amount of all revenues and gains minus the total of all expenses and losses Statement of Cash Flows is required for each period when balance sheet and income statement are presented. It provides information about the cash receipts and cash disbursements of a company: Cash receipts – cash payments = change in cash for the period. It is helpful in assessing future profitability, liquidity, and long-term solvency. Chapters 3: The Accounting Cycle – During the Period Companies have business transactions with may different individuals and companies:  Suppliers, consultants, vendors  Customers  Employees  Creditors (i.e. banks, bondholders)  Investors Transactions are supported by source documents (Purchase orders, invoices, contracts, promissory notes, etc. Transactions that have an economic impact on the company must be measured and recorded. Equity is the area that requires a deeper understanding using what is referred to as the Expanded Accounting Equation: During the month a company records all of its transactions that are naturally occurring, triggered by activities and source documents. This allows them to have ‘Preliminary’ financial statements on the last day of the month. Transactions & Debit/Credits: Each transaction must be recorded in a manner that keeps the Accounting Equation in balance and we use Debits and Credits to do this: All companies use Debit and Credits: Here is one way that some people use to remember Debits and Credits: And here is another alternative: Journal Entries: These are standardized way all companies record transactions and it is used by basic to sophisticated accounting systems. An example is: What the terms “on credit” or “on account” mean in the context of a transaction between two businesses: - When the company buys something: Supplier (vendor) has given our company time to pay them (typically 30 days). Use the Accounts Payable (liability) account to track amounts owed to vendors - When our company sells something: Company has given a customer time to pay (typically 30 days). Use the Accounts Receivable (asset) account to track amounts owed to us Describe what causes each Account to increase and decrease: Posting Transactions: After all transactions are recorded with a Journal Entry the information is POSTED to a journal: Posting is the process of transferring the debit and credit information from the journal to individual general ledger accounts. The general ledger provides, in a single collection, each account with its individual transactions and resulting account balance. T-Accounts: Each account has one and it shows the accumulation of the transactions that have impacted that account  Left side are DEBITS  Right side are CREDITS Total goes on the side that ‘increases’ the account. Trial Balance: Created at the end of each accounting period A trial balance is a list of all accounts and their balances at a particular date, showing that total debits equal total credits. Another purpose of the trial balance is to assist us in preparing adjusting entries. After posting the journal entries to the general ledger accounts, the sum of the accounts with debit balances should equal the sum of the accounts with credit balances. Example Trial Balance: Chapters 4: The Accounting Cycle – End of the Period During the month a company records all of its transactions that are naturally occurring, triggered by activities and source documents. This allows them to have ‘Preliminary’ financial statements on the last day of the month, however, these financial statements would not fully reflect accrual accounting as required by GAAP and therefore ‘adjustments’ need to be made. After that step then final financial statements can be prepared and the accounting period ‘closed’ so that the next can start. This process looks like: The adjustment process is specifically designed to ensure full accrual-basis accounting is followed, Under accrual-basis accounting, we record:  Assets – at the time those resources are obtained  Liabilities – at the time those obligations occur  Revenues – at the time goods and services are provided to customers  Expenses – at the time costs are used in running the company Always ask “When did the true economic event happen?” and use an ‘adjustment’ to reflect the event in the proper accounting period. Adjustments follow two patterns (meaning they are driven by two different scenarios): - Cash FIRST (economic event later) – Adjustments are made to Prepaid Expenses and Deferred Revenue - Cash LATER (economic event first) – Adjustments are made to Accrued Expenses and Accrued Revenue REMEMBER: - Adjustments NEVER touch the Cash Accounting - Adjustments ALWAYS touch a revenue or expense account Prepaid Expenses:  Prepaid expenses arise when a company pays cash (or has an obligation to pay cash) to acquire an asset that is not used until a later period.  There is a timing difference—cash is paid now and then later the expense is recognized.  These payments are recorded as assets at the time of purchase.  In the period these assets are used, an adjusting entry is needed to: o decrease the asset’s balance to its remaining (unused) amount o recognize an expense for the cost of asset used  A particular type of Prepaid Expense that always requires adjustment are Long-Lived assets o Long-lived assets (anything with expected useful life over a year)  Warehouse for products  Trucks used for distribution  Computer systems for inventory tracking and management o Definition of depreciation: “the allocation of cost for long-lived assets over the expected useful life”  Allocation: spread the expense over a long period of time to match expenses to revenues o Accumulated Depreciation is a ‘Contra-Asset’ account used to track the reduction of Plant, Property and Equipment o Adjusting entry is always the same:  Debit Depreciation Expense / Credit Accumulated Depreciation  o Add the Asset (i.e. Equipment) and subtract Accumulated Depreciation to get NET BOOK VALUE Deferred Revenue:  Deferred revenues arise when a company receives cash in advance from customers, but products and services won’t be provided until a later period.  When a company receives cash before providing services to customers, it owes the customer a service in return. This creates a liability.  In the period those services are provided, the liability is settled, and an adjusting entry is needed to o decrease the liability to its remaining amount owed o recognize revenue Accrued Expenses:  Accrued expenses occur when a company has used costs in the current period, but the company hasn’t yet paid cash for those costs.  The company has used these costs to operate the company in the current period and is obligated to pay them.  An adjusting entry is needed to o record the liability to be paid o recognize the cost as an expense Accrued Revenues:  Accrued revenues occur when a company provides products or services but hasn’t yet received cash.  Because the company has provided products and services in the current period and has the right to receive payment, an adjusting entry is needed to o record an asset for the amount expected to be received o recognize revenue Once adjustments are posted a ‘trial balance’ can be prepared: And from there the final financial statements can be prepared. Once that step is complete then the accounting records can be ‘closed’ in order to start the new period. Closing includes:  Transfer the balances of all temporary accounts (revenues, expenses, and dividends) to Retained Earnings  Closing these accounts reduces them to zero to prepare for the next period Typical adjustments include the following Prepaid Expenses Unearned (Deferred) Revenue Accrued Revenue  Accrued Expenses Chapters 5: Revenue and Receivables Revenues result from delivering goods or services as part of an entity’s core operations.  Recognition occurs at a single point in time when control of a good or service is transferred to the customer on a specific date.  Indicators that transfer has occurred and that revenue should be recognized include the seller having the right to receive payment, the customer having legal title and physical possession of the asset, the customer formally accepting the asset, and the customer assuming the risks and rewards of ownership.  It is important not only to determine how much revenue to recognize (record), but also when to recognize it. GAAP requires companies to follow the following process in determining when and how much revenue to recognize: Core Principle: Companies recognize revenue when goods or services are transferred to customers for the amount the company expects to be entitled to receive in exchange for those goods and services  When: upon transfer to customers  How much: amount the seller is entitled to receive A performance obligation is likely satisfied if the customer has any of the following:  An obligation to pay the seller  Received legal title to the good or received the service  Physical possession of the asset  Assumed the risk and reward of ownership to the good or receiving the service  Accepted the goods or service Contracts often involve receiving cash in advance of satisfying a performance obligation  Requires recognition of a liability called deferred revenue, or unearned revenue Revenue is recognized over a period of time if any of following three criteria is met :  The customer consumes the benefit of the seller’s work as it is performed (example: a subscription)  The customer controls the asset as it is created (example: constructing a building extension)  The seller is creating an asset that has no alternative use to the seller and the seller has the legal right to receive payment for progress to date (example: an order of jets customized for the U.S. Air Force) Revenue is recognized in proportion to the amount of performance obligation that has been satisfied Net Revenues: Companies often offer discounts and guarantees that can reduce the amount of cash the company is entitled to receive from those customers:   Sales returns  Trade discounts – a reduction of the selling price  Sales discounts – a discount rewarding prompt payment Net revenues equals total revenues less any amounts for returns and discounts. Sales Discounts: Reduction in the amount to be received from a credit customer if collection on account occurs within a specified period. Accounts Receivable: Accounts Receivable exists when companies make sales ‘on credit’. Credit sales transfer goods or services to a customer today while bearing the risk of collecting payment from that customer in the future. Because allowing customers time to pay there is credit risk and that risk needs to be estimated and recorded in the financial statements. GAAP requires that we account for uncollectible accounts using the allowance method. Companies must:  Estimate the amount of current accounts receivable that will prove to be uncollectible in the future.  Report this estimate as a contra asset to its accounts receivable. Under the allowance method, a company reports its accounts receivable for the net amount expected to be collected. Bad debt expense is part of operating expenses: Write-off of a specific customer account receivable: When it becomes clear a customer will not pay, the company writes off the customer’s account balance as uncollectible. The write-off:  DECREASES the balance of Accounts Receivable.  DECREASES the balance of the contra account Allowance for Uncollectible Accounts. The write-off has no effect on total assets (balance sheet) or total expenses (income statement). There are two approaches to estimating the ‘allowance for uncollectible accounts’: Once the needed Allowance balance is calculated then the ‘adjustment’ is what will be necessary to force the account to be that: Utilizing an Aging of Accounts Receivable is the way to calculate Step 1 – the ending balance the account ‘Allowance for Uncollectible Accounts’ needs to have: Then knowing if the current balance in the Allowance account is a DEBIT or a CREDIT is critical. Either way we need to get to the same ending balance but it will change the adjustment we record. General – Explanation of Balance Sheet Accounts Cash – Asset = Amounts that are in cash at bank Beginning Balance + Cash Receipts/Inflows – Cash Disbursement/Outflows = Ending Balance Accounts Receivable – Asset = Used to track amounts customers owe the company for services already provided. Customers will pay the company in the future. Beginning Balance + Credit Sales to Customers – Cash Receipts from Customers on A/R they owe – Specific Customer Accounts Written Off = Ending Balance Allowance for Uncollectible Accounts – CONTRA-Asset = Used to estimate the amount of Accounts Receivable that will not be collected from customers. This account is subtracted from Accounts Receivable to determine ‘Net Realizable Value’ of Accounts Receivable. Beginning Balance + Bad Debt Expense – Specific Customer Accounts Written Off = Ending Balance Prepaid Expenses – Asset = Future expenses (insurance, rent, etc.) that the company paid in advance. As time passes or the item is used up this asset account is reduced and the amount is transferred to an expense account. Beginning Balance + Prepayment for Items purchased prior to consuming them in the business – Consumption/Use of the Asset by the business = Ending Balance Supplies – Asset = Account used to track supplies (office, cleaning, etc.) that the company will use (these items are not things sold to customers) Beginning Balance + Purchases – Used by business = Ending Balance Inventory – Asset = Account used to track the items that the company intends to sell to customers. It should include all costs necessary to get the item ready to be sold. Beginning Balance + Purchases – Items sold to customers – Lower of Cost or Market Adjustment – Adjustment for Shrinkage (Inventory Loss) = Ending Balance Plant, Property and Equipment – Asset = Real Property (tangible) assets that the company has and uses in the operations of its business. Beginning Balance + Purchases – Disposals = Ending Balance Accumulated Depreciation – CONTRA-Asset = Used to track the life to date depreciation expense for Plant, Property and Equipment Beginning Balance + Depreciation Expense – A/D associated with Disposals = Ending Balance Accounts Payable – Liability = Used to track specific amounts owed to specific vendors/supplies to the company. Beginning Balance + Purchases on Credit – Payments to Vendors = Ending Balance Wages (Salaries) Payable – Liability = Used to track amounts of earned but not yet paid that the company’s employees are entitled to. Beginning Balance + New Wages Owing to Employees – Payments to Employees = Ending Balance Unearned (Deferred) Revenue – Liability = Used to track amounts received from customers prior to the company providing the good or service. Beginning Balance + Receipts/payments from Customers in advance of services being provided – Services that were prepaid are provided to Customers = Ending Balance Loans (Notes) Payable – Liability = Used to track principal amounts outstanding that the company must pay in the future. Beginning Balance + Note Proceeds (from banks or other lenders) – Payments to Lender = Ending Balance Interest Payable – Liability = Used to track interest that is owed due to the passage of time but where the payment is not yet due to the lender or bond holder. Beginning Balance + Accrued Interest – Interest Payments = Ending Balance Common Stock (two accounts, one for Par and one for Paid in Capital In Excess of Par) – Equity = Used to the value of common stock issued (if common stock has a par value then amounts will be split between the two accounts Beginning Balance + Stock Issued to Owners or Investors – Stock Redeemed & Retired = Ending Balance Retained Earnings – Equity = Represents the accumulated but undistributed earnings of the company. Beginning Balance + Revenues – Expenses – Dividends = Ending Balance