Accounting Exam 1: Review Sheet

Operating: involve the cash effects of transactions that enter into the determination of net income,
such as cash receipts from sales of goods and services and cash payments to suppliers
and employees for acquisitions of inventory and expenses.

Investing: Generally involve long-term assets and include:

Making and collecting loans.

Acquiring and disposal of investments and productive long-lived assets.

Financing: liability and stockholders; equity items and includes:

Obtaining cash from creditors and repaying the amounts borrowed.

Obtaining capital from owners and providing them with a return, and return of, their
investment.

Current Ratio: A liquidity ratio that measures a company's ability to pay short-term obligations.

Working Capital: A measure of both a company's efficiency and its short-term financial health. The
working capital ratio is calculated as:

Total Debt to Total Assets: A metric used to measure a company's financial risk by determining how
much of the company's assets have been financed by debt. Calculated by adding short-term and longterm debt and then dividing by the company's total assets.

*ASSETS = LIABILITIES + SHAREHOLDERS' EQUITY

A company's assets have to equal, or "balance," the sum of its liabilities and
shareholders' equity.

Financial Statements
Balance Sheet: The balance sheet presents a company's financial position at the end of a specified
date. Some describe the balance sheet as a "snapshot" of the company's financial position at a point (a
moment or an instant) in time. For example, the amounts reported on a balance sheet dated December
31, 2011 reflect that instant when all the transactions through December 31 have been recorded.
3 major components of a balance sheet include:

Assets

Liabilities

Owner's (Stockholders') Equity

Example

Income Statement: measures a company's financial performance over a specific accounting period.
Financial performance is assessed by giving a summary of how the business incurs its revenues and
expenses through both operating and non-operating activities. It also shows the net profit or loss incurred
over a specific accounting period, typically over a fiscal quarter or year.

Sample Products Co.

Income Statement
For the Five Months Ended May 31, 2012
Sales
Cost of goods sold
Gross profit
Operating expenses
Selling expenses
Advertising expense
Commissions expense
Administrative expenses
Office supplies expense
Office equipment expense
Total operating expenses

$100,000
75,000
25,000

2,000
5,000
3,500
2,500

7,000

6,000
13,000

Operating income

12,000

Non-operating or other
Interest revenues
Gain on sale of investments
Interest expense
Loss from lawsuit
Total non-operating

5,000
3,000
(500)
(1,500)
6,000

Net income

$ 18,000

Retained Earnings: A financial statement outlining the changes in retained earnings for a
specified period. The statement of retained earnings reconciles the beginning and ending

retained earnings for the period, using information such as net income from the other
financial statements.
Retained Earnings = Beginning Balance + Net Income Dividends

Trial Balance: A bookkeeping worksheet in which the balances of all ledgers are compiled into debit
and credit columns. A company prepares a trial balance periodically, usually at the end of every reporting
period. The general purpose of producing a trial balance is to ensure the entries in a company's
bookkeeping system are mathematically correct.
-Debits: Assets, Expenses, and Dividends (AED)
-Credits: Liabilities, and Stockholders Equity

Depreciation: Indicates how much of an asset's value has been used up. For example if a company
buys a machine for $1 million and decides it will be useful for 10 years the depreciation of the machine is
$100,000 a year. The accumulated depreciation after 2 years would be $200,000.
-Net book value is the value at which an asset is carried on a balance sheet. To calculate, take
the cost of an asset minus the accumulated depreciation.

Adjusting Entry: Assume a magazine publishing company charges an annual subscription fee of $12.
The cash is paid up-front at the start of the subscription. The income, based on sales basis method, is
recognized upon delivery. Therefore the initial reporting of the receipt of annual subscription fee is
indicated as:
Debit

Credit

---------------Cash

$12

Unearned Revenue

|
|

$12

|
The adjusting entry reporting each month after the delivery is:
Debit

Credit

----------------

Unearned Revenue
Revenue

$1

|
|

$1

|
The unearned revenue after the first month is therefore $11 and revenue reported in the income
statement is $1.

Revenue Recognition: Revenues are recognized in the period when it is earned (buyer and seller have
entered into an agreement to transfer assets) and realized or realizable (cash payment has been received
or collection of payment is reasonably assured).

Expense Recognition: The assets produced and sold or services rendered to generate revenue also
generate related expenses. Accounting standards require that companies using the accrual basis of
accounting and match all expenses with their related revenues for the period, so that the income
statement shows the revenues earned and expenses incurred in the correct accounting period.

Accrual Basis: Events are recognized by matching revenues to expenses (the matching principle) at
the time in which the transaction occurs rather than when payment is made (or received).

Cash Basis: Recognizes revenues and expenses at the time physical cash is actually received or paid
out.

Accounting Underlying Assumptions - Basis for Generally Accepted Accounting

Principles (GAAP)

Entity Assumption - each business is its own accounting entity.

Periodicity Assumption- divide economic activities into time periods for

reporting.

Going Concern Assumption - the company will remain in business and will carry
out existing commitments. Assets will be used to bring
future
benefit and liabilities will be paid.

Monetary Assumption - assume the dollar is stable over time.

No adjustments are made for inflation or deflation.

Accounting Principles:

Historical Cost - Assets and Liabilities are recorded at cost.

Cost is the best estimate of fair value at the time the transaction occurs.

Revenue Recognition: Show revenues on the income statement when:

owe

- the earnings process is judged to be complete or virtually complete(you do not

the customer anything else)
- there is reasonable certainty as to the collectibility of cash (you believe you will be paid)

Comparability - allows users to identify similarities and differences

1) one year to the next
2) one company to another
A format for financial statements is required. It shows trends over time.

Full Disclosure - all relevant accounting information must be disclosed to users.

1) the notes to the financial statements are required
2) the notes to the financial statements discuss details that are not shown
on the financial statements

Matching - expenses incurred should be matched with revenues earned

for the same period.