Financial Accounting (Exam 1 Ch 1-3)
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| Accounting | information and measurement system that identifies, records, and communicates relevant information about a company’s business activities.
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| Accounting equation | equality involving a company’s assets, liabilities, and equity; Assets = Liabilities + Equity; also called balance sheet equation.
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| Assets | resources a business owns or controls that are expected to provide current and future benefits to the business.
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| Audit | analysis and report of an organization’s accounting system, its records, and its reports using various tests.
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| Auditors | individuals hired to review financial reports and information systems.
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| Balance sheet | financial statement that lists types and dollar amounts of assets, liabilities, and equity at a specific date.
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| Bookkeeping | part of accounting that involves recording transactions and events, either manually or electronically; also called recordkeeping.
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| Business entity assumption | principle that requires a business to be accounted for separately from its owner(s) and from any other entity.
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| Common stock | corporation’s basic ownership share; also generically called capital stock.
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| Conceptual framework | the basic concepts that underlie the preparation and presentation of financial statements for external users.
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| Contributed capital | total amount of cash and other assets received from stockholders in exchange for stock; also called paid-in capital.
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| Corporation | business that is a separate legal entity under state or federal laws with owners called shareholders or stockholders.
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| Cost-benefit constraint | the notion that the benefit of a disclosure exceeds the cost of that disclosure.
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| Cost principle | accounting principle that prescribes financial statement information to be based on actual costs incurred in business transactions.
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| Dividends | corporation’s distributions of assets to its owners.
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| Dodd-Frank Wall Street Reform and Consumer Protection Act | to promote accountability and transparency in the financial system, put an end to the notion “too big to fail,” protect the taxpayer by ending bailouts, and protect the consumer from abusive financial services.
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| Equity | owner’s claims on the assets of a business; equals the residual interest in an entity’s assets after deducting liabilities; also called net assets.
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| Ethics | codes of conduct by which actions are judged as right or wrong, fair or unfair, honest or dishonest.
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| Events | happenings that both affect an organization’s financial position and can be reliably measured.
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| Expanded accounting equation | Assets = Liabilities + Equity; Non-corporation Equity = [Owners capital – Owner withdrawals + Revenues – Expenses], Corporation Equity = [Contributed Capital + Retained Earnings + Revenues – Expenses] where dividends are subtracted from retained earnings.
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| Expense recognition principle | prescribes expenses be reported in the same period as the revenues that were earned as a result of the expenses; also called the matching principle.
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| Expenses | outflows or using up of assets as part of operations of a business to generate sales.
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| External auditors | independent of a company and are hired to assess and evaluate the “fairness” of financial statements (or to perform other contracted financial services).
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| External transactions | exchanges of economic value between one entity and another entity.
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| External users | persons using accounting information who are not directly involved in running the organization.
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| Financial accounting | area of accounting aimed mainly at serving external users.
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| Financial Accounting Standards Board (FASB) | independent group of full-time members responsible for setting accounting rules.
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| Full disclosure principle | principle that prescribes financial statements (including notes) to report all relevant information about an entity’s operations and financial condition.
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| Generally accepted accounting principles (GAAP) | rules that specify acceptable accounting practices.
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| Going-concern assumption | principle that prescribes financial statements to reflect the assumption that the business will continue operating.
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| Income | amount earned after subtracting all expenses necessary for and matched with sales for a period; also called net income, profit, or earning.
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| Income statement | financial statement that subtracts expenses from revenues to yield a net income or loss over a specified period of time; also includes any gains or losses.
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| Internal auditors | a company employee who assess and evaluates its system of internal controls, including the resulting reports.
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| Internal transactions | activities within an organization that can affect the accounting equation.
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| Internal users | persons using accounting information who are directly involved in managing the organization.
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| International Accounting Standards Board (IASB) | group that identifies preferred accounting practices and encourages global acceptance; issues International Financial Reporting Standards (IFRS).
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| International Financial Reporting Standards (IFRS) | set of international accounting standards explaining how types of transactions and events are reported in financial statements; issued by IASB
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| Liabilities | creditor’s claims on an organization’s assets; involves a probable future payment of assets, products, or services that a company is obligated to make due to past transactions or events.
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| Managerial accounting | area of accounting aimed mainly at serving the decision-making needs of internal users; also called management accounting.
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| Matching principle | prescribes expenses to be reported in the same period as the revenues that were earned as a result of the expenses; also called expense recognition.
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| Materiality constraint | prescribes that accounting for items that significantly impact financial statement and any inferences from them adhere strictly to GAAP.
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| Measurement principle | principle that prescribes financial statement information, and its underlying transactions and events, be based on relevant measures of valuation; also called the cost principle.
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| Monetary unit assumption | principle that assumes transactions and events can be expressed in money units.
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| Net income | amount earned after subtracting all expenses necessary for and matched with sales for a period; also called income, profit, or earnings.
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| Net loss | excess of expenses over revenues for a period.
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| Partnership | unincorporated association of two or more persons to pursue a business for profit as co-owners.
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| Proprietorship | business owned by one person that is not organized as a corporation; also called sole proprietorship.
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| Recordkeeping | part of accounting that involves recording transactions and events, either manually or electronically; also called bookkeeping.
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| Retained earnings | cumulative income less cumulative losses and dividends.
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| Return | monies received from an investment; often in percent form.
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| Return on assets | ratio reflecting operating efficiency; defined as net income divided by average total assets for the period; also called return on total assets or return on investment.
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| Revenue recognition principle | the principle prescribing that revenue is recognized when earned.
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| Revenues | gross increase in equity from a company’s business activities that earn income; also called sales.
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| Risk | uncertainty about an expected return.
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| Sarbanes–Oxley Act | regulates analyst conflicts, imposes corporate governance requirements, enhances accounting and control disclosures, impacts insider transactions and executive loans, establishes new types of criminal conduct, and expands penalties for violations of federal securities laws.
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| Securities and Exchange Commission (SEC) | Federal agency Congress has charged to set reporting rules for organizations that sell ownership shares to the public.
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| Shareholders | owners of a corporation; also called stockholders.
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| Shares | equity of a corporation divided into ownership units; also called stock.
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| Sole proprietorship | business owned by one person that is not organized as a corporation; also called proprietorship.
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| Statement of cash flows | a financial statement that lists cash inflows (receipts) and cash outflows (payments) during a period; arranged by operating, investing, and financing.
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| Statement of retained earnings | report of changes in retained earnings over a period; adjusted for increases (net income), for decreases (dividends and net loss), and for any prior period adjustment.
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| Stock | equity of a corporation divided into ownership units; also called shares.
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| Stockholders | owners of a corporation; also called shareholders.
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| Time period assumption | assumption that an organization’s activities can be divided into specific time periods such as months, quarters, or years.
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| Account | record within an accounting system in which increases and decreases are entered and stored in a specific asset, liability, equity, revenue, or expense.
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| Account balance, or Balance | difference between total debits and total credits (including the beginning balance) for an account.
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| Balance column account | account with debit and credit columns for recording entries and another column for showing the balance of the account after each entry.
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| Chart of accounts | list of accounts used by a company; includes an identification number for each account.
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| Common stock | corporation’s basic ownership share; also generically called capital stock.
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| Compound journal entry | journal entry that affects at least three accounts.
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| Credit | recorded on the right side; decreases asset and expense accounts, and increases liability, revenue, and most equity accounts; abbreviated Cr.
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| Creditors | individuals or organizations entitled to receive payments.
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| Debit | recorded on the left side; increases assets and expense accounts, and decreases liability, revenue, and most equity accounts; abbreviated Dr.
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| Debt ratio | ratio of total liabilities to total assets; used to reflect risk associated with a company’s debts.
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| Dividends | corporation’s distributions of assets to its owners.
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| Double-entry accounting | accounting system in which each transaction affects at least two accounts and has a least one debit and on credit.
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| General journal | all-purpose journal for recording the debits and credits of transactions and events.
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| General ledger | record containing all accounts (with amounts) for a business; also called a ledger.
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| Journal | record in which transactions are entered before they are posted to ledger accounts; also called book of original entry.
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| Journalizing | process of recording transactions in a journal.
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| Posting | process of transferring journal entry information to the ledger; computerized systems automate this process.
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| Posting reference (PR) column | a column in journals in which individual ledger account numbers are entered when entries are posted to those ledger accounts.
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| Source documents | source of information for accounting entries that can be in either paper or electronic form; also called business papers.
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| T-accounts | tool used to show the effects of transactions and events on individual accounts.
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| Trial balance | list of accounts and their balances at a point in time; total debit balances equal total credit balances.
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| Unearned revenue | liability created when customers pay in advance for products or services; earned when the products or services are later delivered.
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| Accounting cycle | reoccurring steps performed each period.
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| Accounting periods | length of time covered by financial statements; also called reporting periods.
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| Accrual basis accounting | accounting system that recognizes revenues when earned and expenses when incurred; the basis for GAAP.
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| Accrued expenses | costs incurred in a period that are both unpaid and unrecorded; adjusting entries for recording accrued expenses involve increasing expenses and increasing liabilities.
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| Accrued revenues | revenues earned in a period that are both unrecorded and not yet received in cash (or other assets); adjusting entries for recording accrued revenues involve increasing assets and increasing revenues.
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| Adjusted trial balance | list of accounts and balances prepared after period-end adjustments are recorded and posted.
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| Adjusting entry | journal entry at the end of an accounting period to bring an asset or liability account to its proper amount and update the related expense or revenue account.
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| Annual financial statements | financial statements covering a one-year period; often based on a calendar year, but any consecutive 12-month (or 52-week) period is acceptable.
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| Book value | asset’s acquisition cost les its accumulated depreciation (or depletion, or amortization); also sometimes used synonymously as the carrying value of an account.
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| Cash basis accounting | accounting system that recognizes revenues when cash is received and records expenses when cash is paid.
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| Classified balance sheet | balance sheet that presents assets and liabilities in relevant subgroups, including current and noncurrent classifications.
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| Closing entries | entries recorded at the end of each accounting period to transfer end-of-period balances in revenue, gain, expense, loss, and withdrawal (dividend for corporation) accounts to the capital account (to retained earnings for a corporation).
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| Closing process | necessary end-of-period steps to prepare the accounts for recording the transactions of the next period.
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| Contra account | account linked with another account and having an opposite normal balance; reported as a subtraction from the other account’s balance.
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| Current assets | cash and other assets expected to be sold, collected, or used within one year or the company’s operating cycle, whichever is longer.
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| Current liabilities | obligations due to be paid or settled within one year or the company’s operating cycle, whichever is longer.
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| Current ratio | ratio used to evaluate a company’s ability to pay its short-term obligations, calculated by dividing current assets by current liabilities.
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| Depreciation | expense created by allocating the cost of plant equipment to periods in which they are used; represents the expense of using the assets.
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| Expense recognition (or matching) principle | prescribes expenses to be reported in the same period as the revenues that were earned as a result of the expenses.
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| Fiscal year | consecutive 12-month (or 52-week) period chosen as the organization’s annual accounting period.
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| Income Summary | temporary account only used in the closing process to which the balances of revenue and expense accounts (including any gains or losses) are transferred; its balance is transferred to the capital account (or retained earnings for corporations).
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| Intangible assets | long-term assets (resources) used to produce or sell products or services; usually lack physical form and have uncertain benefits.
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| Interim financial statements | financial statements covering less than one year; usually based on one-, three-, or six-month periods.
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| Long-term investments | long-term assets not used in operating activities such as notes receivable and investments in stocks and bonds.
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| Long-term liabilities | obligations not due to be paid within one year or the operating cycle, whichever is longer.
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| Natural business year | twelve-month period that ends when a company’s sales activities are at their lowest point.
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| Operating cycle | normal time between paying cash for merchandise or employee services and receiving cash form customers.
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| Permanent accounts | accounts that reflect activities related to one or more future periods; balance sheet accounts whose balances are not closed; also called real accounts.
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| Plant assets | tangible long-lived assets used to produce or sell products and services; also called property, plant and equipment (PP&E) or fixed assets.
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| Post-closing trial balance | list of permanent accounts and their balances from the ledger after all closing entries are journalized and posted.
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| Prepaid expenses | items paid for in advance of receiving their benefits; classified as assets.
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| Profit margin | ratio of a company’s net income to its net sales; the percent of income in each dollar of revenue; also called net profit margin.
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| Pro forma financial statements | statements that show the effects of proposed transactions and events as if they had occurred.
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| Reversing entries | optional entries recorded at the beginning of a period that prepare the accounts for the usual journal entries as if adjusting entries had not occurred in the prior period.
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| Straight-line depreciation method | method that allocates an equal portion of the depreciable cost of plant asset (cost minus salvage) to each accounting period in its useful life.
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| Temporary accounts | accounts used to record revenues, expenses, and withdrawals (dividends for a corporation); they are closed at the end of each period; also called nominal accounts.
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| Time period assumption | assumption that an organizations’ activities can be divided into specific time periods such as months, quarters, or years.
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| Unadjusted trial balance | list of accounts and balances prepared before accounting adjustments are recorded and posted.
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| Unclassified balance sheet | balance sheet that broadly groups assets, liabilities, and equity accounts.
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| Unearned revenues | liability created when customers pay in advance for products or services; earned when the products or services are later delivered.
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| Working papers | analyses and other informal reports prepared by accountants and manager when organizing information for formal reports and financial statements.
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| Work sheet | spreadsheet used to draft an unadjusted trial balance, adjusting entries, adjusted trial balance, and financial statements.
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| Financial analysis | (1) liquidity and efficiency, (2) solvency, (3) profitability, and (4) market prospects.
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| Explain the purpose and importance of accounting | Accounting is an information and measurement system that identifies, records, and communicates relevant, reliable, and comparable information about an organization's business activities. Identifying business activities requires that we select relevant transactions and events.
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| Identify users and uses of, and opportunities in, accounting | Accounting is called the language of business because all organizations set up an accounting information system to communicate data to help people make better decisions.
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| External Information Users | external users of accounting information are not directly involved in running the organization. They include shareholders (investors), lenders, directors, customers, suppliers, regulators, lawyers, brokers, and the press.
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| Internal Information Users | internal users of accounting information are those directly involved in managing and operating an organization such as the chief executive officer (CEO), chief financial officer (CFO), chief audit executive (CAE), treasurer, and other executive and managerial-level employees.
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| Explain why ethics are crucial to accounting | the goal of accounting is to provide useful information for decisions. For information to be useful, it must be trusted. This demands ethics in accounting. Ethics are beliefs that distinguish right from wrong. They are accepted standards of good and bad behavior.
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| Explain generally accepted accounting principles and define and apply several accounting principles | Generally accepted accounting principles are a common set of standards applied by accountants. Accounting principles aid in producing relevant, reliable, and comparable information. Four principles underlying financial statements were introduced
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| Define and interpret the accounting equation and each of its components | the accounting equation is; Assets = Liabilities + Equity. Assets are resources owned by a company. Liabilities are creditors' claims on assets. Equity is the owner's claim on assets (the residual). The expanded accounting equation is; Assets = Liabilities + [Common Stock − Dividends + Revenues − Expenses].
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| Analyze business transactions using the accounting equation | a transaction is an exchange of economic consideration between two parties. Examples include exchanges of products, services, money, and rights to collect money. Transactions always have at least two effects on one or more components of the accounting equation. This equation is always in balance.
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| Identify and prepare basic financial statements and explain how they interrelate | four financial statements report on an organization's activities; balance sheet, income statement, statement of retained earnings, and statement of cash flows.
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| Compute and interpret return on assets | return on assets is computed as net income divided by average assets. For example, if we have an average balance of $100 in a savings account and it earns $5 interest for the year, the return on assets is $5/$100, or 5%.
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| Explain the steps in processing transactions and the role of source documents | The accounting process identifies business transactions and events, analyzes and records their effects, and summarizes and presents information in reports and financial statements. These reports and statements are used for making investing, lending, and other business decisions.
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| Source documents | identify and describe transactions and events entering the accounting process. They are the sources of accounting information and can be in either hard copy or electronic form. Examples are sales tickets, checks, purchase orders, bills from suppliers, employee earnings records, and bank statements.
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| Describe an account and its use in recording transactions | An account is a record of increases and decreases in a specific asset, liability, equity, revenue, or expense item. Information from an account is analyzed, summarized, and presented in reports and financial statements.
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| Describe a ledger and a chart of accounts | The collection of all accounts and their balances for an information system is called a ledger (or general ledger). The chart of accounts is a list of all ledger accounts and includes an identification number assigned to each account.
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| Define debits and credits and explain double-entry accounting | The left side of an account is called the debit side, often abbreviated Dr. The right side is called the credit side, abbreviated Cr.
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| Double-entry accounting requires that for each transaction | At least two accounts are involved, with at least one debit and one credit.
The total amount debited must equal the total amount credited.
The accounting equation must not be violated.
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| Compute the debt ratio and describe its use in analyzing financial condition | One way to assess the risk associated with a company's use of liabilities is to compute the debt ratio. Debt ratio = Total Liabilities/Total assets.
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| Explain accrual accounting and how it improves financial statements | Accrual accounting recognizes revenue when earned and expenses when incurred—not necessarily when cash inflows and outflows occur. This information is valuable in assessing a company's financial position and performance.
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| Explain how accounting adjustments link to financial statements | Accounting adjustments bring an asset or liability account balance to its correct amount. They also update related expense or revenue accounts. Every adjusting entry affects one or more income statement accounts and one or more balance sheet accounts. An adjusting entry never affects cash.
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| Explain and prepare an adjusted trial balance | An adjusted trial balance is a list of accounts and balances prepared after recording and posting adjusting entries. Financial statements are often prepared from the adjusted trial balance.
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| Prepare financial statements from an adjusted trial balance | Revenue and expense balances are reported on the income statement. Asset, liability, and equity balances are reported on the balance sheet. We usually prepare statements in the following order; income statement, statement of retained earnings, balance sheet, and statement of cash flows.
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| Describe and prepare closing entries | Closing entries involve four steps
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| Explain and prepare a post-closing trial balance | A post-closing trial balance is a list of permanent accounts and their balances after all closing entries have been journalized and posted. Its purpose is to verify that (1) total debits equal total credits for permanent accounts and (2) all temporary accounts have zero balances.
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| Identify steps in the accounting cycle | The accounting cycle consists of 10 steps
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| Explain and prepare a classified balance sheet | Classified balance sheets report assets and liabilities in two categories; current and noncurrent. Noncurrent assets often include long-term investments, plant assets, and intangible assets. A corporation separates equity into common stock and retained earnings.
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| Compute profit margin and describe its use in analyzing company performance | Profit margin is defined as the reporting period's net income divided by its net sales. Profit margin reflects on a company's earnings activities by showing how much income is in each dollar of sales.
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| Compute the current ratio and describe what it reveals about a company's financial condition | A company's current ratio is defined as current assets divided by current liabilities. We use it to evaluate a company's ability to pay its current liabilities out of current assets.
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