Acct 2300 Financial Accounting Review Sheets

ACCT 2300

Review for Test 1

1) What category of accounts are shown in the four big financial statements? (BS, IS, Stmt of RE, Stmt of Cash Flows)

BS- shows the financial position of a business on a certain date which is why it is known as the statement of financial position. The BS is made up of three parts which are assets, liabilities, and equity. The assets can include the depreciation of vehicles and buildings, and retained earnings and stockholder’s equity are included in the financial statement.

IS- the income statement summarizes the revenues earned and expenses incurred by a business over a period of time. The IS includes revenues and expenses to arrive at a net income total.

Stmt of RE- shows the changes in retained earnings over a period of time. The statement includes the beginning retained earnings with profits or losses below, as well as dividends paid in order to arrive at final retained earnings for a specific period of time.

Statement of Cash Flows- statement directed toward the company’s liquidity goal. The statement of cash flows shows the cash produced by operating a business as well as important investing and financing transactions that take place during an accounting period.

Statement of Owner’s Equity- summarizes changes in investor’s interest in company over a preceding period (typically consists of beginning balance + additional investment+ profit or loss- distributions to owners (dividends.))

2) Name the normal balances the accounting elements (A, L, OE, R, E)?

Asset- Debit
Liability- Credit
Shareholder’s Equity- Credit Revenue- Credit
Expense- Debit
Retained Earnings- Credit
Dividend- Debit

3) How do we calculate the Retained Earnings balance on the Balance Sheet? Which statement presents this?)

Retained Earnings is the accumulated net income (revenues-expenses) less dividends over the life of the business. The statement of retained earnings presents the calculation.

4) What is the separate entity assumption?

Economic Entity Concept- business is treated as an “entity” separate from its owners.

5) What is the historical cost principle?

Historical cost describes the original cost of an asset at the time of purchase or payment as opposed to its market value. Historical cost principle dictates that most assets and liabilities should be recorded at their historical cost.

6) What is the Going Concern Assumption?

“Going Concern” principle- business will survive for “foreseeable” future.

7) What accounts make up total stockholders equity?

Contributed Capital and Retained Earnings.

What is Contributed Capital? What is Retained Earnings?

Contributed Capital- the amount that stockholder’s invest in the business.

Retained Earnings- represent the equity of the stockholders generated from the income-producing activities of the business and kept for use in the business.

9) What is the time period assumption?

Accountants assume that it is possible to prepare an income statement that accurately reflects net income or earnings for a specific time period.

10) When do we recognize revenue in agreement with the Revenue Recognition Principle?

The process of determining when revenue is earned, and consequently when it should be recorded. Before revenue is recognized there must be persuasive evidence that an arrangement exists, delivery has occurred or services have been rendered, the seller’s price to the buyer is fixed or determinable, and collectibility is reasonably assured.

11) When do we recognize expenses in agreement with the Matching Principle?

Expenses must be assigned to the accounting period in which they are used to produce revenue.

12) Know how to analyze accounting transactions and prepare journal entries.

13) Go over journal entries from different sources, and be able to prepare them

14) Know how the accounting transactions and events affect the accounting equation: A=L+OE.

15) Which statement explains a company’s operating performance during a specific period of time?

Income Statement

16) Which statement shows a company’s “financial position” at a specific date?

Balance Sheet

17) What is the definition of an Asset? A liability?

Assets- economic resources owned by a business that are expected to benefit future operations.

Liabilities- present obligations of a business to pay cash, transfer assets, or provide services to other entities in the future.

18) What is a Trial Balance?

Trial Balance is prepared at the end of an accounting period. It is an initial check that the ledger is in balance namely debits and credits.

19) Know how to analyze and prepare adjusting journal entries.

Example) Accruals such as accrued expenses and accrued revenues, and Deferrals such as adjustments to prepaid assets, unearned revenue, adjustments to supplies, or the depreciation expense adjustment.
Deferred expenses- cash payment precedes recognition of expense. Pre paid rent and insurance depreciation.
Deferred revenues- cash collection precedes earning of revenue. Pre paid advertising.
Accruals- cash flow has not happened yet but is certain. Interest, taxes. Accruals can be expenses and revenues.

20) Know how to calculate and prepare the adjusting entries that recognize interest expense incurred on a Note Payable, and depreciation expense on equipment.

21) What are closing entries? How often do we close our accounting records? Which accounts do we close? Why do we close those accounts? Be able to prepare a closing journal entry.

Closing entries are journal entries made at the end of an accounting period. Closing entries are required at the end of any period for which financial statements are prepared. Revenues, Expenses, and Dividends are cleared to set the stage for the next accounting period and to summarize revenues and expenses.

22) Know how to analyze transactions, prepare journal entries, and recognize each entry’s effect on the accounting equation. Which accounts are affected? Classify each account. Did the account go up or down? (Should you debit or credit the account to show the direction of the effect?). Does the accounting equation remain in balance after the journal entry is made?

Test Review 2

1) Name the differences between retailers’ and manufacturers’ inventories?

a. What classes of inventory does a manufacturer hold?

Retailers do not have assembly lines or production equipment; therefore merchandise companies have a small dollar amount in operating assets and a large amount in inventory. Manufacturers have three types of costs involved in inventory including raw materials (ingredients), direct labor, and manufacturing overhead (other costs including depreciation and salary of supervisor). The inventories of manufacturers are either raw materials, work in process, or finished goods.

2) How are net sales computed? What items are deducted from gross sales in computing net sales?

Net sales are sales revenue less sales returns and allowances and sales discounts.

3) Compute cost of goods purchased. How does this number differ from cost of goods sold? How about cost of goods available for sale?

Cost of goods purchased is simply the cost of goods purchased in the fiscal year. The cost of goods available for sale is the beginning inventory plus the cost of goods purchased. Cost of goods sold equals the cost of goods available for sale and the ending inventory.

4) How is transportation-in treated in computing cost of goods purchased?

Find the net purchases for the company and then add transportation-in considering the buyer pays for the movement and arrive at the cost of goods purchased.

5) Calculate cost of goods sold or ending inventory when given other relevant information.

6) What is the gross profit ratio, and what is it used for?

The gross profit ratio equals gross profit/revenues, and is used to look at the profitability of a business.

7) When do inventory costs appear as:

a. Assets on the balance sheet?

b. Expenses on the income statement?

LIFO, FIFO, Weighted Average Costing of inventory

a. When prices are rising, which method produces the

i. Highest inventory balances FIFO

ii. Lowest cost of goods sold FIFO

iii. Highest gross profit FIFO

iv. Highest net income FIFO

v. Highest income tax expense FIFO

b. When prices are rising, which method produces the

i. Lowest inventory balances LIFO

ii. Highest cost of goods sold LIFO

iii. Lowest gross profit LIFO

iv. Lowest net income LIFO

v. Lowest income tax expense LIFO

c. When prices are falling, which method produces the

i. Highest inventory balances LIFO

ii. Lowest cost of goods sold LIFO

iii. Highest gross profit LIFO

iv. Highest net income LIFO

v. Highest income tax expense LIFO

d. When prices are falling, which method produces the

i. Highest inventory balances FIFO

ii. Lowest cost of goods sold FIFO

iii. Highest gross profit FIFO

iv. Highest net income FIFO

v. Highest income tax expense FIFO

9) What happens to total assets, equity, and net income if a company overstates its inventory balance? Understates?

Total assets, equity, and net income are overstated if the inventory balance is overstated because the cost of goods sold is understated, and therefore gross margin for the year is overstated. Total assets, equity, and net income are understated if the inventory balance is understated because the cost of goods sold is overstated, and therefore gross margin for the year is understated.

10) What characteristics are necessary for items qualify to be classified as “Cash and cash equivalents” on the balance sheet?

Cash equivalent is an investment that is readily convertible to a known amount of cash and has an original maturity to the investor of three months or less. Note that according to this definition, a six-month bank certificate of deposit would not be classified as a cash equivalent

11) What are the various items on a bank statement that require us to book adjusting entries to the cash account (i.e. items that appear on the bank reconciliation as adjustments to the book balance)?

a. What forms do these entries take (i.e. what accounts are debited and credited)?

12) What items recorded on our books appear on the bank reconciliation as adjustments to the bank balance.

13) Be able to reconcile a bank account.

14) Understand accounts receivable

15) Compute net accounts receivable when given enough information to compute gross accounts receivable and the allowance for doubtful accounts.

16) Be able to compute the allowance for doubtful accounts using:

a) The percentage of net credit sales approach

b) Percentage of net sales say 2%, and directly

c) The percentage of Accounts receivable approach.

17) Compute bad debt expense using

a) The percentage of net credit sales approach

b) The percentage of accounts receivable approach

Test Review 3

1) Understand balance sheet disclosures (for example, are these amounts presented on the balance sheet at their net book values or their original costs) for

a) Property, plant, and equipment (“PP&E”)- net book value

b) Intangible assets- original value unless finite-then net book value.

c) Goodwill- net book value.

2) What items other than the original purchase price can be included in the acquisition cost of PP&E?

The purchase price, taxes paid at time of purchase such as sales tax, transportation charges, and installation costs are all associated with acquisition cost.

3) Know the factors that accountants consider when deciding something is an expense or a capital asset (PP&E).

Capital expenditure- a cost that improves the asset and is added to the asset account. Includes major repairs and additions that will improve the life of the asset or the productivity of the asset.

Revenue expenditure- a cost that keeps an asset in its normal operating condition and is treated as an expense. Minor repairs and normal maintenance are included in revenue expenditures.

4) Under what conditions can a company capitalize interest, or include it as part of the acquisition cost?

If a company constructs an asset over a period of time and borrows money to finance the construction, the amount of interest incurred during the construction period is not treated as interest expense but instead must be included as part of the acquisition cost of the asset. This is referred to as capitalization of interest.

5) What purpose does depreciation serve?

Depreciation is the allocation of the original cost of an asset to the periods benefited by its use.

6) Be able to compute the net book value of property, plant, and equipment and of an intangible asset.

Book value= Acquisition Cost- Accumulated Depreciation. The original cost of an asset minus the amount of accumulated depreciation. Intangible assets can be amortized much faster than PP&E due to technology.

7) Be able to compute depreciation expense and accumulated depreciation using

a) The straight-line method- A method by which the same dollar amount of depreciation is recorded in each year of asset use. Depreciation= (Acquisition cost-Residual Value)/Life.

b) The units-of-production method- Method where the asset’s life is expressed in terms of the number of units that the asset can produce. The depreciation per unit is the following: Depreciation per Unit= (Acquisition Cost-Residual Value)/ Total Number of Units in Asset’s Life. Then the annual depreciation can be calculated as follows: Annual Depreciation= Depreciation per Unit X Units Produced in Current Year.

c) The double-declining-balance method- Method where depreciation is recorded at twice the straight-line rate, but the balance is reduced each period. First, calculate the straight line rate as a percentage. 100%/5 Years= 20%. Then double the amount to equal 40%. Depreciation for 2005 will equal ,000 X 40%= ,000. Then for 2006 Depreciation will equal (20 000- 8000) X 40%= 4 800.

Remember that the methods above deal with residual (salvage) value differently.

Do not use salvage value on double declining, but do use salvage value on straight line and units of production methods. Regardless of the method used, an asset cannot be depreciated to a net book value below its salvage value. If the salvage value is zero, an asset cannot be depreciated below a net book value of zero.

9) Know the income statement and balance sheet effects of using the depreciation methods.

10) Why do companies choose one method of deprecation for financial reporting purposes and another for tax purposes?

When depreciation is calculated for financial statement purposes, a company generally wants to present the most favorable impression (the highest income) possible; therefore the straight-line method is used. However, if the objective of the company’s management is to minimize its income tax liability, then double declining (accelerated depreciation) is used because the company can save more on income taxes because depreciation is a tax shield.

11) Be able to deal with a change in depreciation estimate.

12) Be able to make journal entries to:

a) Record the acquisition of property, plant, and equipment

b) Record depreciation expense on property, plant, and equipment,

c) Record the disposal of property, plant, and equipment. If there are proceeds involved, be able to include these and any gain or loss in your journal entry. Credit gains and debit losses.

13) Be able to make the journal entries described above for natural resources and for intangible assets.

PP&E use word depreciation. Natural resources use word depletion. Intangible assets use word amortization.

14) Know when a liability is a current liability.

Current liabilities are accounts that will be satisfied within one year.

15) Know the types of liabilities that are listed in the current liabilities section of the balance sheet.

Examples include notes payable, accounts payable, income taxes, other taxes, accrued interest, other accrued liabilities, and current maturities of long-term debt.

16) Be able to compute the following:

a) Working capital- Current assets minus current liabilities.

b) Current ratio- current assets to current liabilities. 2:1. Current assets divided by current liabilities.

c) Quick ratio- If the firm has a large amount of inventory, it is somewhat useful to exclude inventory (prepayments are also excluded) when computing the “quick ratio.” Most companies want a quick ratio of 1.5:1.

17) Know when contingent liabilities are:

a) Disclosed, but not recorded- Most lawsuits are not recorded as liabilities either because the risk of loss is not considered probable or because the amount of the loss cannot be reasonably estimated. Must at least be disclosed if there is reasonable possibility. Probable and not estimable, Reasonably Possible and Estimable, or Reasonably Possible and Not Estimable.

b) Recorded- A contingent liability should be accrued and presented on the balance sheet if it is probable and if the amount can be reasonably estimated. A common example is product warranties or guarantees. Another example is premium or coupon offers and legal claims. Most companies give an estimate of total sales such as 2% that will involve the cost of repairing products due to the warranty. Debit Warranty Expense and Credit Estimated Liability.

18) What is the difference between simple and compound interest.

Simple Interest- interest is calculated on the principal amount only. I= P X R X T

Compound Interest- interest calculated on the principal plus previous amounts of interest. Use the charts.

19) You should be able to compute simple interest and compound interest.

20) Know when and how to apply the following calculations:

a) Future value of a single amount (i.e. future value of )

b) Present value of a single amount

c) Future value of an annuity

d) Present value of an annuity.

21) Know the balance sheet presentation of long-term liabilities, including long-term debt.

22) Know the various characteristics of bonds.

23) Know how to calculate the prices of bonds, given the face value of the bonds, the face rate, the market rate, and the term of the bonds.

24) You should be able to make the journal entries associated with:

a) Issuance of bonds (at face value, a premium, or a discount). Debit cash, credit bonds payable and premium on B/P.

b) Amortization (straight-line method) of bond premiums and discounts, along with interest expense. Debit interest expense, credit cash and discount on B/P.

c) Redemption of bonds. Debit bonds payable, credit cash.

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