Introduction to Financial Accounting

Question 1

What is accrual accounting?

Answer 1

Accounting recognition of revenues and expenses tied to business activities, not to cash flows.

Question 2

What are adjusting entries?

Answer 2

Internal transactions that update account balances in accordance with accrual accounting prior to the preparation of financial statements.

Question 3

What are differed revenues & expenses?

Answer 3

• Update existing account balances to reflect current accounting values
• Cash flow in past; record revenue/expense now

Question 4

What are accrued revenues & expenses?

Answer 4

• Create new account balances to reflect unrecorded assets or liabilities
• Record revenue expense now; cash flow in future

Question 5

What type of balance does a contra asset have?

Answer 5

Credit balance

Question 6

What type of balance does an expense have?

Answer 6

Debit balance

Question 7

What is goes on the income statement?

Answer 7

Revenue - Expenses over a given period of time (i.e. 1 quarter, 1 year, 5 years)

Question 8

What are the five major parts and two minor parts of the accounting cycle?

Answer 8

1 - analyze transactions
2 - journalists & post
3 - adjusting entries
    a - unadjusted trial balance
4 - financial statements 
    b - adjusted trial balance
5 - closing entries

Question 9

How do we close entries?

Answer 9

We zero out the expense and revenue accounts and transfer their balances to retained earnings.

Cr. Retained earnings
Dr. Revenue

Dr. Retained earnings
Cr. Expense

Question 10

What is the difference between temporary and permanent accounts?

Answer 10

Temporary Accounts

• accumulate the effects of transactions for a period of time only
• revenue and expense accounts
• closed out to retained earnings at the end of the period

Permanent Accounts

• Accumulate the effects of transactions over the entire life of a business
• balance sheet accounts (assets, liabilities, contributed capital, retained earnings)

Question 11

What does the income statement format consist of?

Answer 11

REVENUE (or Sales)

• Cost of goods sold

GROSS PROFIT

• Operating (SG&A) Expense

OPERATING INCOME

• Interest, Gains and Losses

PRE-TAX INCOME

• Income tax expense

NET INCOME

Question 12

What does the balance sheet format consist of?

Answer 12

ASSETS
Current assets
Non-current assets
(Ordered by liquidity)

LIABILITIES
Current liabilities
Non-current liabilities 
Stockholder's equity
(Ordered by liquidity)

Question 13

What happens in an adjusted trial balance?

Answer 13

• summarize balances in each account after adjusting entries
• used to make financial statements

Question 14

How should you prepare financial statements?

Answer 14

• prepare income statement first
• then use net income to update retained earnings and to prepare balance sheet
• finally, compete the statesmen of cash flows and statement of stockholders equity.

Question 15

The balance sheet only lists what type of accounts?

Answer 15

Permanent accounts

• assets
• liabilities
• contributed capital
• retained earnings

NOT

• revenues
• expenses

Question 16

Why must we close entries before we prepare the balance sheet?

Answer 16

Because the balance sheet only lists permanent accounts. When we close entries we are zeroing out all temporary account in order to prepare the balance sheet.

Question 17

What does the statement of cash flows consist of?

Answer 17

Operating cash flows
Investing cash flows
Financing cash flows

Question 18

What are operating cash flows?

Answer 18

Transactions related to providing goods and services to customers and to paying expenses related to generating revenue (i.e. “Income statement activities)

Question 19

What are investing cash flows?

Answer 19

Transactions related to acquisition or disposal of long-term assets

Question 20

What are financing activities?

Answer 20

Transactions related to owners or creditors

Question 21

Which business activities require the indirect or the direct method of accounting when prepare the statement of cash flows?

Answer 21

Operating

• indirect
• direct
• both are allowed but indirect is required. If you do direct method, you must also do indirect.

Investing
- direct

Financing
- direct

Question 22

What is the essential thing to keep in mind when preparing the statement of cash flows?

Answer 22

We are only accounting for transactions involving the cash account. The cash flow statement is an adjustment of the income statements involving the removal all non-cash accounts.

Question 23

What does EBITDA stand for?

Answer 23

Earning before interest, taxes, depreciation and amortization.

Question 24

What is the definition of free cash flow?

Answer 24

Operating cash flow minus cash for long-term investments.

Question 25

How is free cash flow disclosed?

Answer 25

Companies often disclose cash flow using their own custom definition, not the FASB definition.

Question 26

Why does the change in balance sheet numbers often not equal the number on the SCF?

Answer 26

Because some of the numbers on the balance sheet involve non-cash accounts and are therefore not listed on the SCF.