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ACC2202

Financial Accounting 1

TermDefinition
Ethics standards of conduct by which one's actions are judged as right or wrong; honest or dishonest
Sole Proprietorship a business owned by one person. They are easy to start as they have no special legal requirements, however, the business is not a separate entity from the owner and therefore the owner is responsible for the organization.
Partnership a business ownership is shared between two or more persons in a formalized legal relationship including how profits and loss will be distributed. Income is reported in personal income tax returns
Corporation a corporation is a separate legal entity in which ownership is represented by shares.
Publicly Accountable Enterprises corporations which shares trade openly on the stock market
Private Enterprises corporations in which shares are held by a small group, such as a family
Legal Status of Corporation corporations are separate legal entities which means shareholders are not individually liable for the business' finances. Corporate income is recorded separately as a corporate income tax return
Accounting data - internal users those who directly manage business operations and need accounting data to plan, control, and evaluate business operations. These users have access to more in depth financial reports
Accounting data - external users anyone with a vested interest in the operations of the company (including share holders, bankers , customers, tax regulators, etc.)
IFRS International Financial Reporting Standards - for publicly accountable and private enterprises
ASPE Accounting Standards for Private Enterprise - for private enterprises only
GAAP Generally Accepted Accounting Principles
Reporting Entity Concept an entity which contains users that depend on general purpose financial statements to make decisions
Going Concern Assumption an entity is viewed as continuing to be in business for the foreseeable future
Periodicity Concept each accounting period has an economic activity associated with it, which can be measured, accounted for, and reported on
Fundamental Qualitative Characteristics Relevance: information is capable of influencing decision makers and faithfully presented Representation: information should be complete, neutral, and free of errors
Enhanced Qualitative Characteristics timeliness, verifiability, and understandability
Recognition the specific conditions under which revenue is recognized and accounted for; typically after a critical step has occurred and the amount of revenue in measurable
Measurement using units of money
Assets resources owned by the business
Liabilities claims against the assets (what the business owes)
Owners Equity residual claims of the owner (what is left over)
Business Transactions the recorded economic events of a business which may be external (with other businesses) or internal
Financial Statements are prepared to summarize accounting data; income statement, statement of changes in equity, balance sheets, cash-flow statement
Income Statement presents revenues, expenses and profit (or loss)
Statement of Owner's Equity Statement of Changes in Equity: summarizes changes in owners equity over a specific period of time. Shows period capital balance, investments, profit (loss), owner's drawings and end of period balance
Balance Sheet reports assets, liabilities, and owners equity
Statement of Cash Flows summarizes information concerning cash inflows (receipts) and outflows (payments) over a specific period of time
The Account an individual accounting record of increases or decreases in a specific asset, liability, or owner's equity item (shown as debits and credits)
T-Account an individual accounting record of increases or decreases in a specific asset, liability, or owner's equity item arranged in a T shape due to debits and credits
Debit refers to the left side
Credit refers to the right side
Debit balance when debits exceed credits
Credit balance when credits exceed debits
The Journal transactions are initially recorded in a journal
The General Journal 1. discloses, in one place, the effects of the transaction 2. provides a chronological record of transactions 3. helps prevent or locate errors because debits and credits can be easily compared
Journalizing the act of entering a transaction in the journal
Compound Entry when three or more accounts are required in one journal entry
The Ledger the entire group of accounts maintained by a business, keeping all the information about changing account balances in one place. The ledger tracks debits, credits, and the final balance of all types of accounts according to the Chart of Accounts
The Chart of Accounts literally a list of the accounts a business needs to keep track of; the order starts with permanent accounts starting with assets
Trial balance a trial balance is a list of accounts (in order of the Chart of Accounts) and their balances at a point in time. It proves debits = credits after posting. It also helps find errors
Errors not detected by trial balance 1. transactions that were not journalized 2. a journal entry not posted 3. an entry posted twice 4. incorrect amounts used
Time Period Assumption the economic life of a business can be divided into artificial time periods (e.g. Quarters)
Revenue Recognition/Matching Principle revenue should be recognized in the accounting period in which it is earned; expenses should be matched and recorded in the same time period as the revenues they helped generate
Accrual Basis of Accounting refers to the rules followed under the time period assumption and revenue recognition principle. The alternative is the cash basis where transactions are only recorded at payment. Adjusting entries are done to ensure accrual accounting
Adjusting Entries are made in order to implement accrual accounting to ensue that revenues are recorded in the period in which they are earned and expenses recognized when they occurred. Adjusting entries do not affect cash
Prepaid Expenses are expenses paid in cash and normally recorded as an asset before they are consumed; they expire with the passage of time or through use (supplies, prepaid insurance)
Unearned Revenues revenues received and recorded as liabilities before they are earned; they are subsequently earned by rendering a product or service to a customer (rent, gift cards, subscriptions)
Depreciation is the process of allocating the cost of an asset to expire over its useful life in a systematic manner
Accrued Expenses expenses incurred but not yet paid (rent, taxes, salaries)
Accrued Revenues revenues earned but not yet received payment (services performed but not yet billed)
Adjusted Trial Balance prepared after all adjustments have been made to show the balance of all accounts (including those adjusted). Financial statements can be prepared directly
Closing entries formally recognize in the ledger, the transfer of net income (or loss) and owners drawings to owners capital as shown in the statement of changes of equity
Temporary accounts are accounts which will have balances of $0 after closing entries are recorded and posted. Drawings, revenues, and expense accounts are temporary
Permanent accounts will continue to have balances to prove the equality of the permanent account balances being carried forward into the next accounting cycleQ
Post-Closing trial balance a trial balance to prove the equality of the permanent account balances being carried forward into the next accounting cycle
Reversing Entries are used in conjunction with the accounting systems to account for transactions that extend over a long period of time and overlaps accounting periods. When the next period starts, the amounts accrued will need to be accounted or as an expense.
Classified Balance Sheet group elements into significant subgroups, typically; Assets: current assets, long-term assets, property, plant and equipment, and intangible assets Liabilities and Owner's Equity: current liabilities, long-term liabilities, and owner's equity
Current Assets cash and other resources that are reasonably expected to be realized in cash or sold and consumed in the business within one year or the operating cycle (whichever is longer)
Long-term Investments resources that can be realized in cash but the conversion into cash is not expected within one year or the operating cycle (could be available for sale, investments or hold to maturity of investments)
Property, Plant and Equipment assets of a relatively permanent nature that are used in the business and not intended for sale
Intangible Assets patents, copyrights, goodwill, trademarks, and franchises
Current Liabilities obligations reasonably expect to be paid from existing assets within one year or the current operating cycle
Long-term Liabilities obligations expected to be paid after one year (long term debt). Desirable to list these in order of maturity if possible
Equity Section typically contains the owner's capital account ([owner's] capital), with separate accounts listed for each partner in a partnership. For a corporation these accounts would be listed as shared capital and retained earnings
Liquidity ability to pay current debts as they come due. Acceptable ratios vary but a common benchmark is 1.5 to 2.0. Below 1.5 signals challenges in meeting obligations. 2.0 may signal excess assets which may produce lower returns
Merchandising Company a company that buys and sells goods to make a profit on these activities. Primary revenue is sales
Retailers purchase and sell directly to consumers
Wholesalers purchase and sell to retailers
Perpetual Inventory detailed records of the cost of each inventory item are recorded as well as the cost for which each item is sold is recorded as the sales occur
Periodic Inventory detailed inventory records are not maintained and the cost of goods sold is determined at the end of the accounting period
Trade discounts refer to price breaks often given based on quantities purchased or type of customer (whole salers, retailers, final consumers)
Purchase Discount a discount for early payment
FOB Free on Board - refers to the point where ownership transfers
FOB Shipping Point goods are owned (responsibility of the buyer as soon as they are shipped). The buyer pays the freight costs
FOB Destination goods are the responsibility of the seller until they reach their destination. Seller pays the freight cost
Perpetual Inventory System - Sales sales revenue are recorded when earned (typically when goods are transferred from the seller to the buyer). These transactions should have accompanying documentation (receipts). Taxes are not recorded as revenue (they are a liability due to the gov)
Sales Discounts similar to purchase discounts, sales discounts may be offered to encourage customers to pay invoices more quickly. The sales discount is normally recorded when it is earned by the customer
Sales Returns and Allowances occur when a customer is dissatisfied with their merchandise and is allowed to return it for a refund; reduce revenue accounts and their normal balance is a debit
Multistep Income Statement shows numerous steps in determining profit, including net sales, cost of goods sold, and gross profit. It also distinguishes between operating and non-operating expenses
Operating Expenses made up of selling and administrative expenses
Non-operating Expenses result from secondary or auxiliary operations and are recorded in the income statement after income from operations and are classified as "other revenue and expenses"
Single Step Income Statements do not categorize revenue and expenditures by operating and non-operating. The end result will be the same
Merchandising Inventory includes all goods owned by the company being held for resale
Merchandising Inventory does not include: 1. goods in transit if the ownership has not been transferred (FOB) 2. goods on consignment 3. damaged or obsolete goods
Matching principle main objective in accounting for inventories is to match appropriate costs with sales revenue
FIFO 'first in first out' assumes the costs of the earliest goods acquired are the first to be sold. The cost of goods sold is based on the first units purchased and the ending inventory of the last units purchased
Weighted average method assumes the goods available for sale are homogenous
Specific Identification this method tracks the physical flow of goods continuously. Generally used for the sale of a limited number of high cost items (like cars)
Net Realizable Value the amount a company could reasonably expected to receive on the sale of inventory items. If items are written down and there is evidence NRV is increasing (e.g. hoola hoops make a come back) the write-down can be reversed
Internal Control methods adopted by a business to reduce inefficiency/waste, prevent and detect errors, safeguard assets, enhance the accuracy and reliability of accounting records, achieve effective and efficient operations comply with relevant laws and regulations
Establishment of Responsibility responsibilities for an account should be separate from the physical custody of an asset
Segregation of duties one employee should, without duplicating efforts, provide a valuable basis for the work of another employee; each person should be responsible for their own task
Documentation procedures provide evidence that events have occurred (like receipts)
Human Resource Controls safeguard assets and reduce risk of loss
Physical and IT Controls safeguard assets and records (safes, fences, alarms, etc.)
Independent Checks of Performance review, comparison, and reconciliation of data prepared by one or several employees
Internal Auditors employees of a business that evaluate its effectiveness and system of internal control continuously
External Auditors are independent of the business and examine the internal systems of control in a broader context to determine if the financial position was fairly presented and accurately represent the results of operations
Limitations on Internal Control establishing control procedures should not exceed their expected benefits; employee fatigue or carelessness can undermine the system; collusion may occur is many people work together to avoid procedures; the size of the business may impact controls
Cash physical $ (coins, cheques, etc. that need to go in a bank)
Internal Control over Cash Receipts 1. Authorization 2. Maintain Records 3. Insuring Assets 4. Separating records from keeping custody of assets 5. Separation of duties 6. Technological Controls 7. Auditing
Authorization (receipts) only designated personnel are authorized to handle receipts
Maintain Records (receipts) use remittance advice (mail receipts), cash register tapes, and deposit slips
Insuring Assets (receipts) Bond (obtain fidelity insurance) for people handling cash, require vacations, ensure all cash is deposited daily, segregate duties, ensure different individuals receive cash, hold receipts and hold cash
Separate Record Keeping from Custody of Assets (receipts) the person in charge of the asset should not have access to record keeping
Separation of Duties (receipts) divide the responsibility for assets between two or more employees
Tech controls (receipts) apply technological controls
Auditing (receipts) perform audits and internal reviews of procedures and accounting
Internal Control over Cash Disbursements 1. Authorization 2. Maintain Records 3. Segregation of Duties 4. Safe-guard Assets and records 5. Independent verification 6. Other control
Authorization (disbursements) only authorized personnel can sign cheques
Maintain Records (disbursements) used pre-numbered cheques and account for them in sequence
Segregation of Duties (disbursements) different individuals approve and make payments; cheque signers do not disclose imbursements
Safe-guard assets and records (disbursements) keep blank cheques in safes etc.
Independent Verification (disbursements) compare cheques to invoices, reconcile bank statements monthly
Other Controls (disbursements) stamp invoices 'paid' etc.
Petty cash fund used to pay relatively small amounts
Imprest System operation of a petty cash fund; includes establishing the fund, making payments from the fund and replenishing the fund. Accounting entries are required when the fund is established when the fund is replenished or when the amount of the fund is changed
Bank Statements show cheques paid, electronic fund transfers, and other debits against the account, deposits, EFT deposits, and other credits to the account and the balance after each days transactions
Bank Credit Memoranda show items like notes receivable and interest in notes or account balance for the depositor by the bank
Bank Debit Memoranda shows service fees, cost of printing cheques, and bounced (NSF) cheques
Reconciling the Bank Account is necessary because the bank balance and book balance rarely align due to transaction timing and errors. The reconciliation should be done by an employee who doesn't have other cash related duties
Reporting Cash cash on hand, in banks, or petty cash are simply recorded as 'cash' and listed first in the current asset section of the balance sheet. Over drafts or negative balance is recorded as a current liabilities
Basic Accounting Equation > Assets = Liabilities + Owner's Equity
Owner's Equity Equation > Owner's Equity = Owner's Capital (investment) - Drawings + Net Income
Net Income Equation > Net Income = Revenue - Expenditure
Business transactions each transaction must have a dual effect on the accounting equation
How are profit and loss related to the owner's equity? as shown on the income statement, they are added (or subtracted) to (from) the beginning balance of owner's capital in the statement of owner's equity
How is owners capital related to the balance sheet? as shown in the owner's equity report, it is reported in the balance sheet
How is cash to be reported to the statement of cash flows? amount of cash shown on the balance sheet is reported in the statement of cash flows
Double entry system equal debits and credits are made in the accounts for each transaction so the total debits must equal the total credits
Assets (system entry) Normal Balance - Debit; increase - debit; decrease - credit (A)
Liabilities (system entry) Normal Balance - Credit; increase - credit; decrease - debit (L)
Capital (systems entry) Normal Balance - Credit; increase - credit; decreased - debit (C)
Revenue (systems entry) Normal Balance - Credit; increase - credit; decrease - debit (R)
Expense (system entry) Normal Balance - Debit; increase - debit; decrease - credit (E)
Withdrawals (systems entry) Normal Balance - Debit; increase - debit; decrease - credit (W)
The recording process 1. analyse each transaction in terms of effects on accounts 2. enter each transaction in a journal 3. transfer the journal info to the appropriate accounts in the ledger
Journal Entry 1. enter the date in the date column 2. enter the debit account title and enter debit amounts in debit column 3. enter credit accounts (indent) and amounts in the credit column 4. ref. column left blank until posting
Posting from the journal to the ledger 1. in the ledger, enter the appropriate columns of the accounts debited to date, journal page, amount 2. in the reference column of journal to write the account number to which the debit account was posted 3. repeat with credit
prepaid expenses debit expense account and credit asset account to adjust the entry
unearned revenues debit to a liability account and credit to a revenue account
depreciation debit to depreciation expense and credit to accumulated depreciation account
depreciation equation > depreciation = total cost/useful life
accrued expenses debit to an expense account and credit to a liability account
accrued revenue debit to an asset account and credit to a revenue account
closing the books of a proprietorship 1. debit each revenue account and credit income summary 2. credit each expense account and debit income summary 3. debit income summary for balance and credit owner's capital 4. debit the owner's capital for owners drawings and credit drawings
the balance in the owner's capital account should equal the ending balance in the statement of changes in equity
Liquidity > working capital = current assets - current liabilities
Liquidity > current ratio = current assets/current liabilities
working capital should be positive
current ratio should be between 1.5 and 2.0
expense for merchandising company = cost of goods sold - operating expenses
net sales = gross sales - sales discounts - sales returns and allowances
gross profit = net sales - cost of good sold
profit = gross profit - operating and non-operating expenses
value of inventory is recorded as an asset at the end of the period
Perpetual Inventory System - Purchases the cost of each item is debited to the merchandise inventory account when purchased, credit accounts payable
Purchase returns and allowances are the same as sales returns and allowances except recorded by the purchaser. Purchase returns and allowances are debited from accounts payable and credited to the merchandise inventory
Purchase account if the buyer is offered and takes advantage of a purchase discount, the amount of the discount is credited to the merchandise inventory account at the time of payment debit accounts payable
Freight cost paid by the seller are referred to as transportation-in debit merchandise inventory, credit cash. When the seller pays it is transport-out and is recorded as operating expense
Sales discount recorded as a debit to the sales account and credit to accounts receivable
sales returns and allowances (unusable) debit returns and allowances and credit the customers accounts receivable.
sales returns and allowances (usable) if the merchandise can be resold debit merchandise inventory and credit cost of good sold
gross profit ratio = gross profit/net sales
Closing entries - perpetual inventory same as previous closing approaches but sales need to be debited and credited to the income summary; sales discounts, returns and allowances and cost of goods sold need to be credited and debited from income summary
periodic inventory system - purchases when merchandise is purchased for resale to customers the temporary account 'purchase' is debited and either cash or accounts payable credited
purchase returns and allowances credit purchase returns and debit account payable
purchase discount credit purchase discount debit accounts payable
cost of goods purchased balance of purchase account - balances contra account + transport-in account
period inventory system - sales sales are credited and cash or accounts receivable are debited
periodic inventory system - sales discount debit sales account and credit accounts receivable
periodic inventory system - sales returns and allowances debit sales returns and allowances and credit accounts receivable
periodic inventory - cost of goods sold = inventory beginning + cost of goods purchased - inventory end
periodic inventory - cost of goods purchased net purchases - transport-in
net purchases = purchases - returns and allowances - discounts
periodic inventory - goods available for sale = inventory beginning + cost of goods purchased
periodic inventory - closing entries 1. the beginning inventory balance is debited to income summary and credited to merchandise inventory 2. the ending inventory balance is debited to merchandising inventory and credited to income summary 3. all other accounts closed in the normal manner
weighted average cost = cost of good available/total number of goods
Impact of changes in prices under FIFO if prices are rising this will result in the lowest 'cost of goods sold' amount and the highest 'net income' (when prices fall the reverse is true)
constancy principle you cannot change the type of system you use just to make net income look better
to establish petty cash debit petty cash and credit cash
to replenish petty cash debit petty cash and all the things you bought and credit cash
cash over and shortage is debited (shortage) or credited (overage) if the petty cash spending is slightly outside the amount of the fund
steps to preparing a bank reconciliation 1. determine the deposits in transit 2. determine the outstanding cheques 3. note any errors discovered 4. trace bank memoranda to records *reasons for discrepancies should be recorded
Created by: alentini