FA2016Q4 Flashcards
What are the three different business entities?
- Sole proprietorships
- Partnerships
- Corporations
What are non-business entities?
Government entities
- Federal government and its agencies
- State and local governments and their agencies
Private organizations
- Hospitals, universities, cooperatives and philanthropic organizations/NGOs
Here you typically use fund accounting
What is a liability?
A liability is an obligation of a business: for example when a company borrows money at a bank.
What is a creditor?
Someone to whom a company or person has a debt. Also called a lender.
What is an asset?
A future economic benefit; a valuable resource to the company that controls it. For example cash, buildings and equipment, inventory. It does not have to be tangible but could be intangible such as a patent right.
What are the three areas of business activities?
- Financing: borrowing, sale of stock
- Operating activities: Sale of products/services + costs incurred to operate
- Investment: purchase and sale of assets
Who are the users of accounting information?
- Internal users: The management
- External users:
- Stockholders and potential stockholders
- Bondholders, bankers and other creditors
- Government agencies
- Other: suppliers, trade associations, stockbrokers, financial analysts
What is ratio analysis?
Looking at relationships among financial statement items
What is horizontal analysis?
Looking at trends over time.
What is vertical analysis?
Comparing financial statement items in a single period
What is the accounting equation?
Assets = Liabilities + Owners’ equity (stockholder/shareholders equity)
What is the balance sheet?
The balance sheet is the financial statement that summarizes the assets, liabilities and owners’ equity at a specific point in time. It is also called the statement of financial position (Balancen fra VØ)
What is the income statement?
The income statement is a statement that summarizes revenues and expenses. It is also called the statement of income (Resultatopgørelsen fra VØ)
What are dividends?
Distribution of net income of a business to its owners. They are NOT on the income statement.
What is the statement of retained earnings?
The statement that summarizes income earned and dividends paid over the life of a business.
What is the statement of cash flows?
The financial statement that summarizes a company’s cash receipts and cash payments during the period from operating, investing and financing activities (Pengestrømsopgørelsen I VØ)
What is the cost principle?
The cost principle is such that assets are recorded at the cost to acquire them. It is also called the original cost/historical cost (later you can adjust to for example fair value).
What is the principle of going concern?
The assumption that an entity is not in the process of liquidation and that It will continue indefinitely.
What is the time period assumption?
The assumption that it is possible to prepare an income statement that accurately reflects net income or earnings for a specific time period.
What is the monetary unit?
The monetary unit is the currency used, which is important in the sense that internationally trading entities profits are strongly affected by exchange rate changes.
Who determines the rules for financial statements?
- SEC: Securities and exchange commission
- FASB: The Financial Accounting Standards Board
- AICPA: American Institute of Certified Public Accountants (the professional organization of CPA: Certified public accountants)
- PCAOB: Public company accounting oversight board
- IASB: The international accounting standards board
- GAAP: Generally accepted accounting principles
What is auditing?
The process of examining the financial statements and the underlying records of a company to render an opinion as to whether the statements are fairly presented. Big corporations will have external auditors looking through/testing the procedures used.
What is the concept of material errors?
After an auditor has looked through a financial report, the report should now only have material errors; material errors is errors that are so small that it would not change the users’ perception of the report (subjective definition but auditors will look at the percentage difference between their calculations of, for example, revenue or assets and the stated value. If the difference is small, it is typically accepted. In other words, a financial report is most likely, not completely, accurate).
What are the main qualities of good financial reporting?
- Understandability
- Relevance
- Faithful representation
- Comparability and consistency
- Materiality (linked to relevance but deals with the size of an error in accounting information)
- Conservatism; using the least optimistic estate when two estimates of amounts are about equally like
What is the operating cycle and how do you start it?
Started when capital is invested in inventory.
What is a current asset?
An asset that is expected to be realized in cash or sold or consumed during the operating cycle or within one year if the cycle is shorter than one year.
What are good examples of non-current assets?
- Investments; in land held for future office sites
- Property, plants and equipment
- Intangible assets such as a franchise agreement
What is a current liability?
A current liability is an obligation that will be satisfied within the next operating cycle or within one year if the cycle is shorter than one year.
What is a long-term liability?
Any obligation that will not be paid or otherwise satisfied within the next year of the operating cycle, whichever is longer, is classified as a long-term liability, or a long-term debt.
What is working capital?
Current assets minus current liabilities. The difference between current assets and liabilities at a point in time.
How do you calculate the current ratio?
Current assets divided by current liabilities. It shows you the relative liquidity. The ratio rule of thumbs is different from industry to industry both 2 is an often used ratio to analyze short-term financial health.
What is a single-step income statement?
An income statement in which all expenses are added together and subtracted from all revenues.
What is a multiple-step income statement?
An income statement that shows classifications of revenues and expenses as well as important subtotals.
What are the most important questions to ask yourself when evaluating any financial statement ratio?
- How does this year’s ratio differ from ratios of prior years?
- How does the ratio compare with industry norms?
How do you make a simple ratio analysis?
- Question: How liquid is the company? Or how profitable is the company?
- Find information on current assets + current liabilities or net income + net sales
- Calculate the ratio
- Compare with other ratios (prior years + competitors)
- Interpret the ratios
What should be taken into account when deciding whether to lend a company money or not, or investing in a company or not? (not limited to these things)
- Liquidity (current ratio)
- Income statement regarding profitability
- Cash flows in and out
- Outlook for the industry
- Outlook for the economy (inflation + growth rates)
- Interest rates for similar loans during the term of the loan
- Alternative uses of the bank’s money
What is the difference between external and internal events?
External events; An event involving interaction between the entity and its environment. For example paying wages to an employee or a sale to a customer.
Internal events; occurs entirely within the entity. It could be the use of a piece of equipment.
What is a transaction?
Any event (external or internal) that is recognized in a set of financial statements.
What is a source document?
A piece of paper that is used as evidence to record a transaction (invoices, cash register tapes, time cards – bilag på dansk)
What is an account and why do we use it?
A record used to accumulate amounts for each individual asset, liability, revenue, expense, and component of stockholders equity. Used to simplify the financial statements.
What is a general ledger?
Simply a book, a file, a hard drive, or another device containing all of the accounts.
What does “debit” and “credit” refer to?
It simply means the left side (debit) and right side (credit) of a T-account. Whether debiting increases or decreases an account depends on the account. Assets increased with debit, liabilities increased with credit.
How do you increase revenues and retained earnings?
- Retained Earnings is increased with a credit.
- Revenue is an increase in Retained Earnings.
- Revenue is increased with a credit.
- Because revenue is increased with a credit, it is decreased with a debit.
How do you increase expenses and retained earnings?
- Retained Earnings is decreased with a debit.
- Expense is a decrease in Retained Earnings.
- Expense is increased with a debit.
- Because expense is increased with a debit, it is decreased with a credit.
How do you increase dividends and retained earnings?
- Retained Earnings is decreased with a debit.
- Dividends are a decrease in Retained Earnings.
- Dividends are increased with a debit.
- Because dividends are increased with a debit, they are decreased with a credit.
What is the double-entry system?
A system of accounting in which every transaction is recorded with equal debits and credits and the accounting equation is kept in balance.
What is a journal?
The book of original entry; A chronological record of all transactions. Any transaction first enters the journal and is then posted to the ledger accounts.
What is a trial balance?
A list of each account and its balance; used to prove equality of debits and credits (showing that the accounting equation has been adhered).
Even though debit and credit is equal, it does not mean that the trial balance is without errors; transactions can have been placed on the wrong accounts.
What is recognition and why do we call financial numbers “representations”?
The process of recording an item in the financial statements as an asset, a liability, revenue, an expense or the like.
Accountants make representations of the company’s assets. We don’t show the building but represent it by a dollar-value.
What is the concept of accrual accounting?
Revenues are recognized when earned and expenses are recognized when incurred – Incurred as in responsible/liable for paying, since the service/product has been delivered.
What is the matching principle?
Associated to cost. The association of revenue of a period with all of the costs necessary to generate that revenue (examples: commissions, inventory of the good sold).
What is the definition of expenses by FASB?
Outflows of assets or incurrences of liabilities resulting from delivering goods, rendering services, or carryout out other activities.
What is adjusting entries?
Journal entries made at the end of a period by a company using the accrual basis of accounting (not needed if cash basis is used)
It is an adjustment of either an assets or a liability with a corresponding change in revenue or expenses
What are the four types of adjusting entries?
- Cash paid before expense is incurred – for example printer-paper in the office, supplies, insurance policy (Deferred expense)
- Cash received before revenue is earned – a gift card, subscriptions, (Deferred revenue)
- Expense incurred before cash is paid; wages payable, interest payable, taxes as examples (Accrued Liability)
- Revenue earned before cash is received; rent receivable for example (Accrued Asset)
What is the straight-line method?
The assignment of an equal amount of depreciation to each period.
What does deferral mean?
Cash has been paid or received but expense or revenue has not yet been recognized (deferred expense and deferred revenue).
What does accrual mean?
Cash has not yet been paid or received but expense has been incurred or revenue earned (Accrued Liabilities and Accrued Assets)
What is the purpose of closing entries?
- To return the balance of revenue, expense, and dividend accounts to zero to begin the next period; and
- To transfer the net income of the period to retained earnings
What is the difference between real and nominal accounts?
Real accounts are permanent and are not closed at the end of the period, whereas nominal accounts (revenue, expense and dividend accounts) are temporary and are closed at the end of the period (will return to 0).
What are interim financial statements?
Financial statements prepared monthly, quarterly, or at other intervals less than a year in duration.
What are the steps in the accounting circle?
What is a non-current asset/non-current liability?
An asset or a liability that you cannot turn into cash within 12 months.
What is the balance sheet model and how do you increase assets?
What is the balance sheet model and how do you increase liabilities?
What is the balance sheet model and how do you increase capital?
What are the two types of inventory?
- Finished inventory; Retailers and wholesalers (merchandise inventory)
- Unfinished inventory (raw materials); Manufacturers
What are the three types of manufacturing costs?
- Direct materials – raw materials
- Direct labor (production workers wage)
- Manufacturing overhead; all other costs related to manufacturing (depreciation of building and machines, salary to the supervisor etc.)
What are the three forms of inventory?
- Direct materials
- Work in process/progress
- Finished goods
What is net sales? (calculation)
Sales – Sales return and allowances – Sales discounts
How do you calculate gross profit?
Net sales – Cost of goods sold
What is the “Sales Returns and Allowances” account for?
Contra-revenues account used to record refunds to customers and reductions of their accounts.
What is the “sales discounts” account for?
A contra-revenue account used to record discounts given to customers for early payment of their accounts (think B2B paying within 10 days on a 30-day contract as example).
How do you calculate cost of goods available for sale?
Beginning inventory + cost of goods purchased
How do you find the “cost of goods sold” for a given company?
Cost of goods available for sale – Ending inventory
Where Cost of goods available = beginning inventory + purchases of inventory
What are the two inventory systems and what is the difference?
- Perpetual system: the inventory account is increased at the time of each purchase and decreased at the time of each sale
- Periodic system: the inventory account is updated only at the end of the period
What is the “Purchases” account for, what should you remember and where will you see it?
- Used in periodic inventory system to record acquisitions of merchandise
- Is NOT an asset account but
- Is included in the income statement as an integral part of the calculation of cost of goods sold and is therefore shown as an increase in expenses and thus a reduction in net income and stockholders’ equity in the accounting equation
What does FOB mean and what is the difference between FOB destination point and FOB shipping point?
- FOB: Free on board
- Destination point; seller pays for shipping costs
- Shipping point: buyer pays for the shipping costs
How do you calculate the gross profit ratio and why is it important?
Gross profit/net sales (overskudsgrad)
It shows the gross profit percentage of an increase in sales
Why is it important to determine the real value of inventories?
The value assigned to an asset such as inventory on the balance sheet determines the amount eventually recognized as an expense on the income statement.
What are the four inventory costing methods?
- Specific identification method; matching unit costs with the actual units sold
- Weighted average cost method; assigning the same unit cost to all units available for sale during the period.
- FIFO: First-in, First-out method; assigns the most recent costs to ending inventory
- LIFO: Last-in, First-out; assigns the most recent costs to cost of goods sold
What is LIFO liquidation?
The result of selling more units than are purchased during the period, which can have negative tax consequences if a company is using LIFO; You sell the “old” and cheap purchases so that your profits increase and tax bill increases.
What is the LIFO conformity rule?
The IRS-requirement (government) that when LIFO is used on a tax return, it must also be used in reporting income to stockholders. In other words, the same method has to be used throughout all financial statements.
What happens when the ending inventory is overstated?
Cost of goods sold is understated, gross profit and net income is overstated, taxes overstated and both assets + and retained earnings (balance sheet) will be overstated.
What happens when the ending inventory is understated?
Cost of goods sold is overstated, net income is understated, taxes understated and both assets + and retained earnings (balance sheet) will be understated.
What is the lower-of-cost-or-market rule? (LCM rule)
A conservative inventory valuation approach that is an attempt to anticipate declines in the value of inventory before its actual sale; if you expect your inventory to be worth less on the market when selling, its value depreciates and you will have a lose on decline in value of inventory.
What is the inventory turnover ratio and how is it calculated?
A measure of the number of times inventory is sold during the period
Inventory turnover ratio: Cost of goods sold/Average inventory
Remember to compare with previous years + competitors ratios.
When should you increase and decrease accounts in the cash flow statement when inventory increases/decreases and accounts payable increases/decreases? (indirect method)
- Increase in inventory > Deducted; the company is building up its stock of inventory and thus expending cahs
- Decrease in inventory > added to net income
- Increase in accounts payable > Added; the company increased the amount it owes suppliers
- Decrease in accounts payable > Deducted; debt to suppliers is decreased
Why is it important to distinguish between inventories costing methods for a perpetual and periodic system?
The three inventory costing methods—FIFO, LIFO, and weighted average—may be used in combination with a perpetual inventory system.
- The inventory costing method is applied after each sale of merchandise to update the Inventory account.
- The results from using LIFO differ depending on whether a periodic or perpetual system is used. The same is true with weighted average, which is called moving average in a perpetual system.
What is the classification of cash?
An amount that is available to pay debts.
What is cash equivalent?
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 >>> Readily means within 3 months.
What does cash management mean?
Managing the need to have enough cash on hand to ensure cash flow needs but not so much that excess funds earn little return and may be vulnerable to misappropriation.
What is bank reconciliation?
A form used by the accountant to reconcile or resolve any differences between the balances shown on the bank statement for a particular account with the balance shown in the accounting records.
What is a petty cash fund?
Money kept on hand for making minor disbursements in coin and currency rather than by writing checks.
What is an internal control system for?
Ensure the safeguarding of an entity’s assets, the reliability of its accounting records, and the accomplishment of overall company objectives.
What is the Sarbanes-Oxley act?
An act of congress in 2002 intended to bring reform to corporate accountability and stewardship in the wake of a number of major corporate scandals >>> Increased requirements to documentations and internal control.
- Management must render an opinion on the efficiency of the company’s internal control system
- Auditors also must increase their documentation and understanding of the internal controls of their clients
What is the internal control report?
A report required by the Sarbanes-Oxley act to be included in a company’s annual report in which management assesses the effectiveness of the internal control structure.
What are some of the most important internal control procedures?
- Proper authorization; only certain personnel may authorize transactions
- Segregation of duties; physical custody of assets must not be combined with the ability to account for those assets
- Independent verification
- Safeguarding of assets and records; both must be adequately protected
- Independent review and appraisal (by internal audit staff)
- Design and use of business documents; source document control
No internal control system is bulletproof.
What are cash discrepancies?
When money “disappear” due to theft by dishonest employees and to human errors; giving the wrong amount of change to a customer.
What is a purchase requisition form?
A form a department uses to initiate a request to order merchandise
What is a purchase order?
A form sent by the purchasing department to the supplier
What is a blind receiving report?
A form used by the receiving department to account for the quantity and condition of merchandise received from a supplier
What is an invoice approval form?
A form the accounting department uses before making payment to document the accuracy of all information about a purchase.
What are the 5 steps of the Financial Decision Model?
- Formulate the Question
- Gather Information from the Financial Statements and Other Sources
- Analyse the Information Gathered
- Make the Decision
- Monitor Your Decision
What are the 5 steps of the Ratio Analysis Model?
- Formulate the Question
- Gather the Information from the Financial Statements
- Calculate the Ratio
- Compare the Ratio with Other Ratios
- Interpret the Ratios
Visualize the debit and credit model; assets, liabilities, contributed capital, retained earnings; expenses, revenues
What is account receivable?
A receivable arising from the sale of goods or services with a verbal promise to pay.
What are the two methods of estimating bad debts (allowance method)?
- A percentage of net credit sales approach
- A percentage of accounts receivable approach
What is a subsidiary ledger and a control account?
The detail for a number of individual items that collectively make up a single general ledger account.
The control account is the general ledger account that is supported by a subsidiary ledger.
What is bad debt?
Unpaid customer accounts that are uncollectible.
What is the direct write-off method regarding bad debts and what are the two main issues?
The recognition of bad debts expense at the point an account is written off as uncollectible >>> bad debt expense is increased.
Issues:
- When not estimating the real value of the accounts receivable, you are overstating the value of the asset until you realize that it is uncollectible.
- You are violating the matching principle as you are overstating net income by ignoring bad debts as expense (by estimation) until the bad debt actually occur as you realize it is uncollectible.
What is the allowance method regarding bad debts?
A method of estimating bad debts on the basis of either the net credit sales of the period or the accounts receivable of the period >>> Allowance account is reduced.
What is the “allowances for doubtful accounts” for and when is it used?
It’s a contra-asset account used to reduce accounts receivable to its net realizable value (estimate from the allowance method).
What is an aging schedule?
A form used to categorize the various individual accounts receivable according to the length of time each has been outstanding. The longer is as been outstanding, the less likely the account receivable is to be collected.
What is the accounts receivable turnover ratio and how is it calculated?
A measure of how well a company manages its receivables; the number of times accounts receivable is collected during a period.
Accounts receivable turnover ratio = Net credit sales / Average accounts receivable
This can be recalculated into days as well: Number of days in the period / Accounts receivable turnover ratio.
What is a promissory note?
A written promise to repay a definite sum of money on demand or at a fixed or determinable date in the future.
What is a note receivable?
An asset resulting from the acceptance of a promissory note from another company.
What are common ways for companies to accelerate the inflow of cash from sales?
- Letting customers use credit cards, lets merchants pass on the responsibility for collection of money to the credit card company.
- Discounting notes receivable; selling a check (as promissory note) to the bank, and receive cash before the note’s maturity date.
What are equity securities?
Securities issued by corporations as a form of ownership in the business >>> stocks
What are debt securities?
Securities issued by corporations and governmental bodies as a form of borrowing >>> bonds
What is CDs?
Certificate of deposits >>> the most liquid form a company can invest their idle cash for a period of time while earning interest revenue.
How do you calculate interest?
Interest = Principal (starting value) x Interest rate x Time
Interest = 100.000 x 0.06 x 90/360 = 1,500.
