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| Primary Objective of External Financial Reporting | Is to provide useful economic information about a business to help external parties, primarily investors and creditors, make sound financial decisions |
| Decision Makers | Are the users of accounting information (users include average investors, creditors, experts who provide financial advice, suppliers, customers, etc.)= Users of accounting info. are usually interested in info. to assist them in projecting a business's future cash inflows and outflows |
| Decision Makers: Creditors and potential creditors | Need to assess an entity's ability to (1) pay interest on a loan over time and also (2) pay back the principal on the loan when it is due |
| Decision Makers: Investors and Potential Investors | Want to assess the entity's ability to (1) pay dividends in the future and (2) be successful so that the stock price rises, enabling investors to sell their stock for more than they paid |
| Accounting Assumptions | 3 of the 4 basic assumptions that underline accounting measurement and reporting relating to the balance sheet |
| Separate-Entity Assumption | States that each business's activities must be accounted for separately from the activities of its owners, all other persons, and other entities= (This means that when an owner purchases land for personal use, the property is not an asset of the business) |
| Unit-of-Measure Assumption | States that each business entity accounts for and reports its financial results primarily in terms of the national monetary unity (e.g. dollars in US, yen in Japan, etc.) |
| Continuity Assumption | (sometimes called the GOING-CONCERN ASSUMPTION) States that a business is normally assumed to continue operating long enough to meet its contractual commitments and plans= (EX: If a company was not expected to continue due to the likelihood of bankruptcy, then its assets and liabilities should be valued and reported on the balance sheet as if the company were to be liquidated [i.e. discontinued] with all of its assets sold and all debts paid) |
| Time Period Assumption | Provides guidance on measuring revenues and expenses |
| Assets, liabilities, & shareholders' equity | Are the elements of a corporation's balance sheet |
| Assets | Are economic resources with probable future benefits owned or controlled by an entity as a result of past transactions (i.e. they are the acquired resources the entity can use to operate in the future) |
| Assets: How to report | To be reported, assets must have a measurable/verifiable value, usually based on the PURCHASED AMOUNT= However, managers use judgment and past experience to determine an acquired asset's most likely future benefit (EX: If 10,000 is owed, but experience shows that only 9,000 will actually be acquired by the company, than 9,000 [the more probable/conservative figure] is reported to users for purposes of projecting future cash flows) |
| Historical Cost Principle | (aka Cost Principle) Cost is measured on the date of the transaction as the cash paid plus the dollar value of the NONCASH CONSIDERATIONS (=any assets, privileges, or rights) also given in the exchange= MEANING: This principle requires assets to be recorded at historical cost that, on the date of the transaction, is cash paid plust the current dollar value of all noncash considerations also given in the exchange (EX: If you trade you computer plus cash for a new car, the cost of the new car is equal to the cash paid plus the market value of the computer) |
| How do most companies list assets on their Balance Sheet? | IN ORDER OF LIQUIDITY (= how soon an asset is expected to be turned into cash or used) |
| Current Assets | Are those resources that the company will use to turn into cash within one year (the next 12 months)= INVENTORY is ALWAYS considered a current asset regardless of the time needed to produce and sell it |
| Long Term Assets | Assets that are to be used or turned into cash beyond the coming year |
| Liabilities | Are probable debts or obligations (claims to a company's resources) that result from an entity's past transactions and will be paid for with assets or services= Those entities that a company owes money to are called CREDITORS |
| Creditors | Are the entities that a company owes money to= They usually receive payment of the amounts owed and sometimes interest on those amounts |
| How do most companies list liabilities on their Balance Sheet? | IN ORDER OF MATURITY (= how soon an obligation is to be paid) |
| Current Liabilities | Are the liabilities that a company will need to pay/settle within the coming year (with cash, services, or other current assets) |
| What does distinguishing Current Assets and Current Liabilities do? | Assists external users of the financial statements in assessing the amounts of timing of future cash flows= Most corporations report current assets and liabilities separately, even though classifying them as such is NOT REQUIRED |
| Stockholders' Equity | (aka Owners' Equity or Shareholders' Equity) Is the financing provided by the owners and by business operations |
| Contributed Capital | Is owner-provided cash (and sometimes other assets)= Owners invest in the business and receive shares of stock as evidence of ownership |
| Why do owners invest (or buy stock) in a company? | Invest/buy stock in the hope of receiving 2 types of cash flows: DIVIDENDS and CAPITAL GAINS |
| Dividends | Are a distribution of a company's earnings (a return on the shareholders' investment) |
| Capital Gains | Are gains from selling the stock for more than they paid |
| Retained Earnings | Refers to the cumulative earnings of a company that are not distributed to the owners and are instead reinvested in the business (by management) |
| Transactions | Is (1) an exchange of assets or services for assets, services, or promises to pay between a business and one or more external parties to a business or (2) a measurable internal event such as the use of assets in operations |
| What business events are recorded on the balance sheet? | Only economic resources and debts resulting from pst transactions are recorded on the balance sheet |
| Transactions: Types of events | Transactions include 2 types of events: (1) External Events and (2) Internal Events |
| External Events | (Is 1 type of transaction event) These are EXCHANGES of assets, goods, or services by one party for assets, services, or promises to pay (LIABILITIES) by one or more other parties (EX: buying a machine from a supplier, investment of cash in the business by the owners, borrowing cash from bank, etc.) |
| Internal Events | (Is 1 type of transaction event) Includes certain events that are not exchanges between the business and other parties but nevertheless have a direct and measurable effect on the entity (EX: using up insurance paid in advance and using buildings/equipment over several years) |
| What types of events that have a future economic impact on a company are NOT reflected in the financial statements? | Signing a contract is not considered to be a transaction because it involves ONLY THE EXCHANGE OF PROMISES, not of assets such as cash, goods, services, or property= However, long-term employment contracts, leases, and other commitments may need to be disclosed in NOTES to the financial statements |
| Account | Is a standardized format that organizations use to accumulate the dollar effect ot transactions on each financial statement item= (the resulting balances are kept separate for financial statement purposes) |
| Chart of Accounts | Is a list of all account titles and their unique numbers= Each company establishes a chart of accounts to facilitate the recording of transactions= EACH COMPANY HAS ITS OWN CHART OF ACCOUNTS!!!= Once you select a name for an account, you must use the exact name in all transactions affecting that account |
| Chart of Accounts: Organization | Are usually organized by financial statement element, with ASSET ACCOUNTS listed first, followed by liability, stockholders's equity, revenue, and expense accounts in that order |
| Describe: Accounts with "receivable" in the title | Are always ASSETS= They represent amounts owed by (receivable from) customers and others to the business |
| Describe: Accounts with "payable" in the title | Are always LIABILITIES= They represent amounts owed by the company to be paid to others in the future |
| Describe: The account Prepaid Expenses | Is an ASSET since it represents amounts paid to others for future benefits, such as future insurance coverage or rental of property |
| Describe: Accounts with "unearned" in the title | Are always LIABILITIES= They represent amounts paid in the past to the company by others expecting future goods or services from the company |
| Describe the accounts you see in the financial statements of most large corporations | The accounts are actually summations (or aggregations) of a number of specific accounts= (EX: Papa John's keeps separate accounts for paper supplies, food supplies, and beverage supplies, but combines them under SUPPLIES on the balance sheet)= Equipment, buildings, and land are also combined into an account called PROPERTY AND EQUIPMENT |
| Manager's business decisions and their affect on the financial statements | Managers' business decisions often result in transactions that affect the financial statements |
| Transaction Analysis | Is the process of studying a transaction to determine its economic effect on the entity in terms of the ACCOUNTING EQUATION (aka FUNDAMENTAL ACCOUNTING MODEL) |
| What is the basic accounting equation for a business that is organized as a corporation? | Assets(A)= Liabilities(L) + Stockholders' Equity (SE) |
| What are the 2 principles underlying the Transaction Analysis process? | Every transaction affects at least 2 accoutns; correctly identifying those accounts and the direction of the effect (whether an increase/decrease) is critical= The Accounting Equation must remain in balance after each transaction |
| Dual Effects Concept | Is the idea that every transaction has AT LEAST 2 EFFECTS on the basic accounting equation= Most transactions with external parties involve an EXCHANGE by which the business entity both receives something and gives up something in return |
| Example: Papa John's purchased napkins for cash. | In this exchange, Papa John's would receive supplies (increase in an asset) and in return would give up cash (a decrease in an asset) |
| Example: Papa John's purchased napkins on credit | Papa John's is engaging in 2 transactions: (1) The purchase of an asset on credit (here, Papa John's would get supplies [increase in an asset] and would give in return a promise to pay later called ACCOUNTS PAYABLE [an increase in a liability]) and (2) the eventual payment (Papa John's would eliminate or get back its promise to pay [a decrease in the Accounts Payable liability] and would give up Cash [a decrease in an asset]) |
| What activity does not result in an accounting transaction that is recorded? | The exchange of 2 promises to perform does NOT result in an accounting transaction that is recorded= Only when the promise is actually exchanged for the good (e.g. when the napkins are finally shipped and Papa John's promise is accepted) does a transaction actually take place) |
| Balancing the Accounting Equation | The Accounting Equation MUST remain in balance after each transaction (i.e. Total Assets [resources] = Total Liabilities + Stockholders' Equity [claims to resources]) |
| Describe a systematic transaction analysis | STEP 1: Identify and classify accounts and effects= Identify the accounts (by title) affected, making sure that at least 2 accounts change= Classify them by type of account (was each account an asset[A], a liability[L], or a stockholders' equity[SE])= Determine the direction of the effect (did the account increase [+] or decrease [-]= STEP 2: Verify accounting equation is in balance= Verify that the accounting equation (A= L + SE) remains in balance |
| Financing Transactions | Companies that need cash for INVESTING purposes (to buy/build additional facilities) often seek funds by selling stock to investors or by borrowing from creditors |
| Accounting Cycle | Highlights the primary activities performed during the accounting period to analyze, record, and post transactions |
| During the accounting period, transactions that result in exchanges between the company and other external parties are | Analyzed and recorded in the GENERAL JOURNAL in chronological order, and the related accounts are updated in the GENERAL LEDGER |
| General Ledger | Is where the related accounts |
| Transaction Analysis Model | (pg. 61) The increase symbol + is located on the left side of the T for accounts on the left side of the accounting equation (assets) and on the right side of the T for accounts on the right side of the equation (Liabilities and Stockholders' Equity) |
| Debit | (dr for short) Is the left side of an account= Is always written on the left side of an account (on the T-transaction analysis model) |
| Credit | (cr for short) Is the right side of an account= Is always written on the right side of each account (on the T- transaction analysis model) |
| Transaction Analysis Model: Asset Accounts | Increase on the LEFT (debit) side= They have debit balances= It would be very unusual for an asset account (e.g. Inventory) to have a negative (credit) balance |
| Transaction Analysis Model: Liability and Stockholders' Equity Accounts | Increase on the right (credit) side, creating credit balances |
| How can you check if you Transactional Analysis is correct? | If you have identified the correct accoutns and effects through transaction analysis, the ACCOUNTING EQUATION will remain in balance= Thus, the total dollar value of all debits will equal the total dollar value of all credits (Debits= Credits) |
| Equality Check | Debits-value = Credits-value |
| General Journal | (aka Journal) In a bookkeeping system, is where transactions are recorded in chronological order= After analyzing the business documents that describe a transaction, the bookkeeper enters the effects on the accounts in the journal using debits and credits |
| Journal Entry | Is an accounting method for expressing the effects of a transaction on accounts= It is written in a debits-equal-credits format |
| Journal Entry: Steps when writing | The debited accounts are written first (on top) with the amoutns on the left side of the 2 columns= The credited accounts are written below the debits and are usually indented in manual records= The credited amounts are written in the right column= THe order of the debited accounts or credited accounts does not matter, as long as the debits are on top and the credits are on the bottom and indented to the right= Total debits EQUALS total credits |
| Compound Entry | Is any journal entry that affects more than 2 accounts |
| What happens after the journal entries have been recorded? Why? | By themselves, journal entries do NOT provide the balances in accounts= After the journal entries have been recorded, the bookkeeper posts (transfers) the dollar amounts to each account affected by the transaction to determine the new account balances |
| General Ledger | Is the name of the group of the accounts that were affected by the transaction |
| T-Account | Is a useful tool for summarizing the transaction effects and determining the balances for individual accounts= Is a simplified representation of a LEDGER ACCOUNT |
| T-Account: Steps when writing | For Cash (which is classified as an asset), increases are shown on the left and decreases on the right side of the T-Account= For Notes Payable, increases are shown on the right and decreases on the left since Notes Payable is a LIABILITY |
| Classified Balance Sheets | (Balance sheets that have multiple periods presented) When multiple periods are presented, the most recent balance sheet amounts are usually listed on the left |
