Financial Recording and Accounting for Lawyers Prep PDF

Chapter 1 Takeaways: 1.1 Recognize the information conveyed in each of the four basic financial statements and the way that it is used by different decision makers (investors, creditors, and managers). The balance sheet is a statement of financial position that reports dollar amounts for the assets,...

Chapter 1 Takeaways: 1.1 Recognize the information conveyed in each of the four basic financial statements and the way that it is used by different decision makers (investors, creditors, and managers). The balance sheet is a statement of financial position that reports dollar amounts for the assets, liabilities, and stockholders’ equity at a specific point in time. The income statement is a statement of operations that reports revenues, expenses, and net income for a stated period of time. The statement of stockholders’ equity explains changes in stockholders’ equity accounts (common stock and retained earnings) that occurred during a stated period of time. The statement of cash flows reports inflows and outflows of cash for a stated period of time. The statements are used by investors and creditors to evaluate different aspects of the firm’s financial position and performance. 1-2. Identify the role of generally accepted accounting principles (GAAP) in determining financial statement content and managers’, directors’, and auditors’ responsibilities for ensuring accuracy of the financial statements. GAAP refers to the measurement rules used to develop the information in financial statements. Knowledge of GAAP is necessary for accurate interpretation of the numbers in financial statements. Management has primary responsibility for the accuracy of a company’s financial information. Auditors are responsible for expressing an opinion on the fairness of the financial statement presentations based on their examination of the reports and records of the company. Users will have confidence in the accuracy of financial statement numbers only if the people associated with their preparation and audit have reputations for ethical behaviour and competence. Management and auditors also can be held legally liable for fraudulent financial statements. Key Terms: Accounting ⇒ A system that collects and processes (analyzes, measures, and records) financial information about an organization and reports that information to decision makers. Accounting Entity ⇒ The organization for which financial data are to be collected. Accounting Period ⇒ The time period covered by the financial statements. Audit ⇒ An examination of the financial reports to ensure that they represent what they claim and conform with generally accepted accounting principles. Balance Sheet (Statement of Financial Position) ⇒ Reports the amount of assets, liabilities, and stockholders’ equity of an accounting entity at a point in time. Basic Accounting Equation (Balance Sheet Equation) Assets = Liabilities + Stockholders’ Equity. Faithful Representation ⇒ Requires that the information be complete, neutral, and free from error. Generally Accepted Accounting Principles (GAAP) ⇒ The measurement and disclosure rules used to develop the information in financial statements. Income Statement (Statement of Income, Statement of Earnings, Statement of Operations)⇒ Reports the revenues less the expenses of the accounting period. Internal Controls ⇒ Processes by which a company provides reasonable assurance regarding the reliability of the company’s financial reporting, the effectiveness and efficiency of its operations, and its compliance with applicable laws and regulations. Notes (Footnotes) ⇒ Provide supplemental information about the financial condition of a company, without which the financial statements cannot be fully understood. Primary Objective ⇒ of Financial Reporting to External Users To provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity. Relevant Information⇒ Information that can influence a decision; it has predictive and/or feedback value. Statement of Cash Flows (Cash Flow Statement)⇒ Reports inflows and outflows of cash during the accounting period in the categories of operating, investing, and financing. Statement of Stockholders’ Equity The statement reports the changes in each of the company’s stockholders’ equity accounts during the period. Total Stockholders' Equity = Contributed Capital + Retained Earning Chapter 2 Takeaways: 2-1. Define the key accounting assumptions, principles, and elements related to the balance sheet. Assumptions: Separate entity assumption—Transactions of the business are accounted for separately from transactions of the owner. Going concern assumption—A business is expected to continue to operate into the foreseeable future. Monetary unit assumption—Financial information is reported in the national monetary unit without adjustment for changes in purchasing power. Principles: Historical cost principle—Financial statement elements should be recorded at the cash-equivalent cost on the date of the transaction; however, these values may be adjusted to other amounts, such as market value, depending on certain conditions. Elements of the balance sheet: Assets—Economic resources owned or controlled by a company; they have measurable value and are expected to benefit the company by producing cash inflows or reducing cash outflows in the future. Liabilities—Measurable obligations resulting from a past transaction; they are expected to be settled in the future by transferring assets or providing services. Stockholders’ equity—Residual interest of owners in the assets of the entity after settling liabilities; the financing provided by the owners (contributed capital) and by business operations (earned capital). 2-2. Identify what constitutes a business transaction and recognize common balance sheet account titles used in business. External transaction⇒ An exchange of cash, goods, or services for cash, goods, services, or promises between a business and one or more external parties to a business (not the exchange of a promise for a promise), or Internal transaction⇒A measurable internal event, such as adjustments for the use of assets in operations. An account is a standardised format that organisations use to accumulate the dollar effects of transactions related to each financial statement item. Typical balance sheet account titles include the following: Assets: Cash, Accounts Receivable, Inventory, Prepaid Expenses, Investments, Property (buildings and land) and Equipment, and Intangibles (rights without physical substance). Liabilities: Accounts Payable, Notes Payable, Accrued Expenses Payable, Unearned Revenues, and Taxes Payable. Stockholders’ Equity: Common Stock, Additional Paid-in Capital, and Retained Earnings. -3. Apply transaction analysis to simple business transactions in terms of the accounting model: Assets = Liabilities + Stockholders’ Equity. To determine the economic effect of a transaction on an entity in terms of the accounting equation, each transaction must be analyzed to determine the accounts (at least two) that are affected. In an exchange, the company receives something and gives up something. If the accounts, direction of the effects, and amounts are correctly analyzed, the accounting equation will stay in balance. Systematic transaction analysis includes (1) determining the accounts that were received and were given in the exchange, including the type of each account (A, L, or SE), the amounts, and the direction of the effects, and (2) determining that the accounting equation remains in balance. 2-4. Determine the impact of business transactions on the balance sheet using two basic tools: journal entries and T-accounts. Journal entries express the effects of a transaction on accounts in a debits-equal-credits format. The accounts and amounts to be debited are listed first. Then the accounts and amounts to be credited are listed below the debits and indented, resulting in debit amounts on the left and credit amounts on the right. Each entry needs a reference (date, number, or letter). T-accounts summarize the transaction effects for each account. These tools can be used to determine balances and draw inferences about a company’s activities. 2-5. Prepare a trial balance and simple classified balance sheet and analyze the company using the current ratio. A trial balance lists all accounts and their balances, with debit balances in the left column and credit balances in the right column. The two columns are totaled to determine if debits equal credits. Classified balance sheets are structured as follows: Assets are categorized as current assets (those to be used or turned into cash within the year, with inventory always considered a current asset) and noncurrent assets, such as long-term investments, property and equipment, and intangible assets. Liabilities are categorized as current liabilities (those that will be paid with current assets) and long-term liabilities. Stockholders’ equity accounts are listed as Common Stock (number of shares x par value per share) and Additional Paid-in Capital (number of shares x excess of issue price over par value per ➗ share) first, followed by Retained Earnings (earnings reinvested in the business). The current ratio (Current Assets Current Liabilities) measures a company’s liquidity, that is, the ability of the company to pay its short-term obligations with current assets. Current ratio measures the ability of the company to pay its short-term obligations with current assets. Although a ratio above 1.0 indicates sufficient current assets to meet obligations when they come due, many companies with sophisticated cash management systems have ratios below 1.0 2-6. Identify investing and financing transactions and demonstrate how they impact cash flows. A statement of cash flows reports the sources and uses of cash for the period by the type of activity that generated the cash flow: operating, investing, and financing. Investing activities include purchasing and selling investments and long-term assets, and making loans and receiving principal repayments from others. Financing activities include borrowing from and repaying to banks the principal amount on loans, issuing and repurchasing stock, and paying dividends. Key Terms: Account ⇒A standardised format that organisations use to accumulate the dollar effect of transactions on each financial statement item Accounting Cycle ⇒ The process used by entities to analyse and record transactions, adjust the records at the end of the period, prepare financial statements, and prepare the records for the next cycle Additional Paid-in Capital ⇒ (Paid-in Capital, Contributed Capital in Excess of Par) The amount of contributed capital less the par value of the stock Assets ⇒ Economic resources owned or controlled by a company; they have measurable value and are expected to benefit the company by producing cash inflows or reducing cash outflows in the future Common Stock ⇒ The basic voting stock issued by a corporation Cost (Historical Cost) ⇒ The cash-equivalent value of an asset on the date of the transaction Credit ⇒ The right side of an account Current Assets ⇒ Assets that will be used or turned into cash within one year Current Liabilities⇒ Short-term obligations that will be paid or settled within the coming year in cash, goods, other current assets, or services Debit ⇒ The left side of an account Going Concern Assumption ⇒ Businesses are assumed to continue to operate into the foreseeable future (also called the continuity assumption) Journal Entry ⇒ The accounting method for expressing the effects of a transaction on accounts in a debits-equal-credits format Chapter 3 Takeaways: 3-1. Describe a typical business operating cycle and explain the necessity for the time period assumption. The operating cycle, or cash-to-cash cycle, is the time needed to purchase goods or services from suppliers, sell the goods or services to customers, and collect cash from customers. Time period assumption—to measure and report financial information periodically, we assume the long life of a company can be cut into shorter periods. 3-2. Explain how business activities affect the elements of the income statement. Elements of the income statement: a. Revenues—the amounts earned and recorded from a company’s day-to-day business activities, mostly when a company sells products or provides services to customers or clients (the central focus of the business). b. Expenses—the costs of operating the business that are incurred to generate revenues during the period. c. Gains—result primarily from the disposal of assets for more than their cost minus the amount of cost depreciated in the past. d. Losses—result primarily from the disposal of assets for less than their cost minus the amount of cost depreciated in the past. 3-3. Explain the accrual basis of accounting and apply the revenue and expense recognition principles to measure income. In accrual basis accounting, revenues are recognized when earned and expenses are recognized when incurred. Revenue recognition principle—recognize revenues (1) when the company transfers promised goods or services to customers (2) in the amount it expects to be entitled to receive. The five-step model for determining when and the amount to recognize revenue is: (1) identify the contract, (2) identify the seller’s performance obligations (promised goods and services), (3) determine the transaction price, (4) allocate the transaction price to the performance obligations, and (5) recognize revenue when each performance obligation is satisfied. Expense recognition principle (matching)—recognize expenses when they are incurred in generating revenue (a matching of costs with benefits). (COSTS ARE RECOGNIZED AS EXPENSES ON THE INCOME STATEMENT) 3-5. Prepare a classified income statement. Until the accounts have been updated to include all revenues earned and expenses incurred in the period (due to a difference in the timing of when cash is received or paid), the financial statements are unadjusted: Income Statement—net income is needed to determine ending Retained Earnings; classifications include Operating Revenues, Operating Expenses (to determine Income from Operations), Other ➗ Items (to determine Pretax Income), Income Tax Expense, Net Income (or Net Loss), and Earnings per Share [Net income (or loss) Weighted average number of shares of common stock outstanding]. ➗ 3-6. Compute and interpret the net profit margin ratio. The net profit margin ratio (Net Income [or Net Loss] Net Sales [or Operating Revenues]) measures the profit generated per dollar of sales (operating revenues). The higher the ratio when compared to competitors or over time, the more effective the company is at generating revenues and/or controlling costs. Net profit margin ratio measures the profit generated per dollar of sales (operating revenues). A high ratio as compared to competitors or over time suggests that a company is generating revenues and/or controlling expenses more effectively. 3-7. Identify operating activities and demonstrate how they affect cash flows. On the Statement of Cash Flows, operating activities include those primarily with customers and suppliers, but interest payments and earnings on investments are also included, unlike how these are reported on the income statement (under Other Items). Only when cash is received or paid in an operating activity is the statement of cash flows affected. Key Terms: Accrual Basis Accounting⇒ Revenues are recognized when goods and services are provided to customers, and expenses are recognized in the same period as the revenues to which they relate, regardless of when cash is received or paid Expense Recognition Principle (or Matching Principle) ⇒ Expenses are recorded in the same time period when incurred to generate revenue Expenses ⇒The costs of operating the business that are incurred to generate revenues during the period Gains⇒ Result primarily from the disposal of assets for more than their cost minus the amount of cost depreciated in the past Losses ⇒Result primarily from the disposal of assets for less than their cost minus the amount of cost depreciated in the past Operating (Cash-to Cash) Cycle⇒ The time it takes for a company to pay cash to suppliers, sell goods and service to customers, and collect cash from customers Operating Income (Income from Operations) ⇒ Net sales (operating revenues) less operating expenses (including cost of goods sold) Revenue Recognition Principle ⇒ Revenues are recognized when the company transfers promised goods or service to customers in the amount it expects to receive Revenues ⇒ The amounts earned and recorded from a company’s day to-day business activities, mostly when a company sells products or provides services to customers or clients Time Period Assumption ⇒ The long life of a company can be reported in shorter periods, such as months, quarters and years Chapter 4 Takeaways: 4-1. Explain the purpose of adjustments and analyze the adjustments necessary at the end of the period to update revenues and expenses and related balance sheet accounts. Adjusting entries are necessary at the end of the accounting period to measure income properly, correct errors, and provide for adequate valuation of balance sheet accounts. These are the types: Deferrals: Revenue earned and cash received in the past (recorded as a liability)—Increase revenue, decrease liability Expense incurred and cash paid in the past (recorded as an asset)—Increase expense, decrease asset Accruals: Revenue earned and cash to be received in the future (not yet recorded)—Increase revenue, increase asset (receivable) Expense incurred and cash to be paid in the future (not yet recorded)—Increase expense, increase liability (payable) Recording adjusting entries has no effect on the Cash account. ➗ 4-3. Compute and interpret the total asset turnover ratio. The total asset turnover ratio (Net Sales (or Operating Revenues) Average Total Assets) measures sales generated per dollar of asset. A rising total asset turnover signals more efficient management of assets. Key terms: Accrued Expenses ⇒ Liabilities (payables) created when expenses are incurred, but cash will be paid in the future; created at end of period during the adjustment process to reflect the amount of expense incurred that the company will pay in the future Accrued Revenues ⇒ Assets (receivables) created when revenues are earned, but cash will be collected from customers in the future; created at end of period during the adjustment process to reflect the amount of revenue earned by providing goods or services over time to customers who will pay in the future Adjusting Entries ⇒ Entries necessary at the end of the accounting period to measure all revenues and expenses of that period and update assets and liabilities Closing Entries ⇒ Made at the end of the accounting period to transfer balances in temporary (income statement) accounts to Retained Earnings and to establish a zero balance in each of the temporary accounts for beginning the next accounting period Contra-Account ⇒ An account that is an offset to, or reduction of, the primary account or financial statement section Deferred Expenses ⇒ Assets created when purchased in the past before being used to generate revenues; need to be adjusted at the end of the period to reflect the amount of expense incurred by using the assets over time Deferred (Unearned) Revenues ⇒ Liabilities created from collecting cash from customers before providing goods or services to customers; need to be adjusted at the end of the period to reflect the amount of revenue earned by providing goods or services over time to customers Net Book Value (Carrying Value or Book Value) ⇒ The acquisition cost of an asset less its accumulated depreciation, depletion (of natural resources), or amortisation (of intangible assets) Permanent Accounts ⇒ The balance sheet accounts that carry their ending balances into the next accounting period Post-Closing Trial Balance⇒ Prepared as an additional step in the accounting cycle to check that debits equal credits and all temporary accounts have been closed (have zero balances) Temporary Accounts Income ⇒ statement (and sometimes Dividends Declared) accounts that are closed to Retained Earnings at the end of the accounting perioD N.B. Statement of Cash Flows: Adjusting Entries Do Not Affect Cash Chapter 5 Takeaways: 5-1. Recognize the people involved in the accounting communication process (regulators, managers, directors, auditors, information intermediaries, and users), their roles in the process, and the guidance they receive from legal and professional standards. Management of the reporting company must decide on the appropriate format (categories) and level of detail to present in its financial reports. Independent audits increase the credibility of the information. Directors monitor managers’ compliance with reporting standards and hire the auditor. Financial statement announcements from public companies usually are first transmitted to users through online information services. The SEC staff reviews public financial reports for compliance with legal and professional standards, investigates irregularities, and punishes violators. Analysts play a major role in making financial statement and other information available to average investors through their stock recommendations and earnings forecasts. 5-2. Identify the steps in the accounting communication process, including the issuance of press releases, annual reports, quarterly reports, and SEC filings, as well as the role of online information services in this process. Earnings are first made public in press releases. Companies follow these announcements with annual and quarterly reports containing statements, notes, and additional information. Public companies must file additional reports with the SEC, including the 10-K, 10-Q, and 8-K, which contain more details about the company. Online information services are the key source of dissemination of this information to sophisticated users. 5-3. Recognize and apply the different financial statement and disclosure formats used by companies in practice and analyze the gross profit percentage. Most statements are classified and include subtotals that are relevant to analysis. On the balance sheet, the most important distinctions are between current and noncurrent assets and liabilities. On the income and cash flow statements, the distinction between operating and nonoperating items is most important. The notes to the statements provide descriptions of the accounting rules applied, add more information about items disclosed on the statements, and present information about economic events not included in the statements. 5-4. Analyze a company’s performance based on return on assets and its components and the effects of transactions on financial ratios. ROA measures how well management used the company’s invested capital during the period. Its two determinants, net profit margin and asset turnover, indicate why ROA differs from prior levels or the ROAs of competitors. They also suggest strategies to improve ROA in future periods. The effect of an individual transaction on a financial ratio depends on its effects on both the numerator and denominator of the ratio. Gross profit percentage measures the excess of sales prices over the costs to purchase or produce the goods or services sold as a percentage. It is computed as follows Return on assets (ROA) measures how much the firm earned for each dollar of investment. It is computed as follows Key Terms: Board of Directors ⇒ Elected by the shareholders to represent their interests; its audit committee is responsible for maintaining the integrity of the company’s financial reports. Corporate Governance ⇒ The procedures designed to ensure that the company is managed in the interests of the shareholders. Earnings Forecasts ⇒ Predictions of earnings for the future accounting period, prepared by financial analysts. Financial Accounting Standards Board (FASB) ⇒ The private sector body given the primary responsibility to work out the detailed rules that become generally accepted accounting principles. Form 8-K⇒ The report used by publicly traded companies to disclose any material event not previously reported that is important to investors. Form 10-K ⇒The annual report that publicly traded companies must file with the SEC. Form 10-Q ⇒The quarterly report that publicly traded companies must file with the SEC. Gross Profit (Gross Margin)⇒ Net sales less cost of goods sold. Institutional Investors ⇒ Managers of pension, mutual, endowment, and other funds that invest on the behalf of others. Lenders (Creditors) ⇒ Suppliers and financial institutions that lend money to companies. Material Amounts ⇒ that are large enough to influence a user’s decision. Press Release ⇒ A written public news announcement normally distributed to major news services. Private Investors ⇒ Individuals who purchase shares in companies. Public Company Accounting Oversight Board (PCAOB) ⇒The private sector body given the primary responsibility to work out detailed auditing standards. Securities and Exchange Commission (SEC) ⇒ The U.S. government agency that determines the financial statements and other disclosures that public companies must provide to stockholders and the measurement rules that they must use in producing those statements. Unqualified (Clean) Audit Opinion ⇒ Auditor’s statement that the financial statements are fair presentations in all material respects in conformity with GAAP and that the company maintained effective internal controls over financial reporting. Left to do: Exercises, videos