Financial Accounting Quiz # 1 Study Sheet DEFINITIONS Accounting The information system that identifies, records, and communicates the economic events of an organization to users interested in that information. Accounting equation The equation that states that Assets = Liabilities + Shareholders’ Equity Assets The resources owned or controlled by a business that are expected to provide future economic benefits. Corporation A company organized as a separate legal entity, with most of the rights and privileges of a person. Shares are evidence of ownership. Creditors Users of accounting information, including suppliers, that grant credit (sell on account) to a customer. Deficit A negative balance in retained earnings resulting from cumulative net losses exceeding cumulative net income. Dividends The distribution of retained earnings from a corporation to its shareholders, normally in the form of cash. Expenses The decreases in economic benefits that result from the costs of assets consumed or services used in ongoing operations to generate revenue. External users Users of accounting information that are not involved in managing the organization and do not have access to accounting information other than that which is publicly available, including investors, lenders, and other creditors. Financing activities Activities that report the cash effects of debt or equity financing. These include (1) borrowing or repaying cash from (to) lenders, and (2) issuing or reacquiring shares or paying dividends to investors. Fiscal year An accounting period that is one year long. Generally accepted accounting principles (GAAP) A general guide, having substantial authoritative support, that describes how economic events should be recorded and reported for financial reporting purposes. Income (also known as revenue) The increase in economic benefits that result from the normal operating activities of a business, such as the sale of a product or provision of a service. Income statement (also known as statement of earnings or statement of profit and loss) A financial statement that presents the revenues and expenses and resulting net income or loss of a company for a specific period of time. Internal users Users of accounting information who have access to an organization’s internal accounting information, including company officers, managers, and directors. Investing activities Activities that report the cash effects of purchasing and disposing of longlived assets such as property, plant, and equipment and investments not held for trading. Investors Users of accounting information that have an ownership interest (owns debt or equity securities) in the organization. Lenders Users of accounting information, including bankers, that extend credit to borrowers. Liabilities The debts and obligations of a business. Liabilities are claims of lenders and other creditors on the assets of a business. Loss (also known as net loss) The amount by which expenses are more than revenues. The opposite of net income. Net income (also known as profit or net earnings) The amount by which revenues exceed expenses Operating activities Activities that result from day-to-day operations. They report the cash effects of transactions that create revenues and expenses Partnership A business owned by more than one person. Private corporation A corporation whose shares are not traded on a public stock exchange. Proprietorship A business owned by one person Public corporation A corporation whose shares are publicly traded on a stock exchange. Reporting entity concept The concept that economic activity that can be identified with a particular company must be kept separate and distinct from the activities of the owner(s) and of all other economic entities. Retained earnings The amount of accumulated net income (less net losses, if any) from the prior and current periods that has been retained and reinvested in the corporation for future use and not distributed to shareholders as dividends. Revenue (also known as income) The increase in economic benefits that result from the operating activities of a business, such as the sale of a product or provision of a service. Share capital Shares representing the ownership interest in a corporation. If only one class of shares exists, it is known as common shares. Shareholders’ equity The shareholders’ claim on total assets, represented by the investments of the shareholders (share capital) and undistributed earnings (retained earnings) generated by the company. Statement of cash flows A financial statement that provides information about the cash inflows (receipts) and cash outflows (payments) for a specific period of time. Statement of changes in equity A financial statement that summarizes the changes in total shareholders’ equity, as well as each component of shareholders’ equity, for a specific period of time. Statement of financial position (also known as balance sheet) A financial statement that reports the assets, liabilities, and shareholders’ equity at a specific date. CHAPTER 1 EQUATIONS ORDER OF PREPARING FINANCIAL STATEMENTS WHAT BELONGS ON EACH STATEMENT? Income Statement Revenue Expenses SCOE/ Statement of Changes in Equity Retained earnings Commons Shares Net income Balance Sheet/Statement of Financial Position: Liabilities o Cash, accounts receivable, inventory, prepaid expenses, property and equipment, goodwill, intangible assets, and other types of assets. Assets o accounts payable and accrued liabilities, income tax payable, and long-term debt, as well as other types of liabilities. Shareholders Equity o Share capital,retained earrnings Statements of Cash Flows Operating Activities Financing Activities Investing Activities Total shareholders equity from SCOE CHAPTER 2 STUDY NOTES DEFINITIONS Accounts payable Amounts owed to suppliers for purchases made on credit (on account). Accounts receivable Amounts owed by customers who purchased products or services on credit (on account). Bank indebtedness A short-term loan, such as an operating line of credit, pre-arranged with a bank to cover cash shortfalls. Basic earnings per share A measure of profitability showing the income earned by each common share. It is calculated by dividing income available to common shareholders by the weighted average number of common shares. Comparability An enhancing qualitative characteristic of useful information that enables users to identify and understand similarities in, and differences among, items. Conceptual framework A coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function, and limits of financial accounting statements. Contra asset account An account that is offset against (reduces) another related asset account on the statement of financial position. Examples include allowance for doubtful accounts and accumulated depreciation. Cost constraint The pervasive constraint that ensures that the value of the information provided in financial reporting is greater than the cost of providing it. Current assets Assets that are expected to be converted into cash, sold, or used up within one year of the company’s financial statement date. Current liabilities Obligations that will be paid or settled within one year of the company’s financial statement date. Current maturities of long-term debt The portion of a non-current or long-term loan that is repayable within the current year. Current ratio A measure of liquidity used to evaluate a company’s short-term debt-paying ability. It is calculated by dividing current assets by current liabilities. Current value The price that would be paid to purchase the same asset or paid to settle the same liabilities. Current value basis of accounting Measurement basis that states that certain assets and liabilities should be recorded at their current value. Debt to total assets A measure of solvency showing the percentage of total financing that is provided by lenders and other creditors. It is calculated by dividing total liabilities by total assets. Elements of financial statements A set of broad categories or classes used to group financial information for presentation in the financial statements, such as assets, liabilities, equity, income, and expenses. Faithful representation A fundamental qualitative characteristic describing information that represents economic reality. It must be complete, neutral, and free from material error. Going concern assumption The assumption that the business will remain in operation for the foreseeable future. Held for trading investments Investments in debt securities or equity securities of other companies that are bought with the intention of selling them aft er a short period of time in order to earn income from their price fluctuations. Historical cost basis of accounting Measurement basis that states that assets and liabilities should be recorded at their cost at the time of acquisition. Intangible assets Assets of a long-lived nature that do not have physical substance but represent a privilege or a right granted to, or held by, a company. Inventory Goods held for sale to customers. Liquidity ratios Measures of a company’s shortterm ability to pay its maturing obligations (usually current liabilities) and to meet unexpected needs for cash. These include working capital and the current, receivables turnover, average collection period, inventory turnover, and days in inventory ratios. Long-term investments (also known as investments) Investments in debt securities intended to be held for many years to earn interest, and (2) equity securities of other companies held to generate investment revenue or held for strategic reasons. Non-current assets (also known as long-term assets) Assets that are not expected to be converted into cash, sold, or used up by the business within one year of the financial statement date. Non-current liabilities (also known as long-term liabilities) Obligations that are not expected to be paid or settled within one year of the financial statement date. Notes payable (also known as loans payable) Amounts owed to suppliers, banks, or others that are normally interest-bearing and supported by a written promise to repay. Notes receivable (also known as loans receivable) Amounts owed by customers or others that are normally interest-bearing and supported by a written promise to repay. Objective of financial reporting The provision of financial information about a company that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the company. Operating activities Activities that result from day-to-day operations. They report the cash effects of transactions that create revenues and expenses. Operating cycle Average period of time it takes for a business to pay cash to obtain products or services and then receive cash from customers for these products or services. Prepaid expenses Costs paid in advance of use that benefit more than one accounting period. They are initially recorded as assets and become expenses only when they are used or consumed and no longer have future benefit. Price-earnings (P-E) ratio A profitability measure of the ratio of the market price of each common share to the earnings per share. It reflects investors’ beliefs about a company’s future income potential. Profitability ratios Measures of a company’s operating success for a specific period of time. These include the gross profit margin, profit margin, return on assets, return on common shareholders’ equity, earnings per share, price-earnings, payout, and dividend yield ratios. Property, plant, and equipment Tangible assets, such as land, buildings, and equipment, with relatively long useful lives that are being used to operate the business. Relevance A fundamental qualitative characteristic describing information that makes a difference in a user’s decision. It should have predictive value, confirmatory value, or both, and be material. Solvency ratios Measures of a company’s ability to survive over a long period of time by having enough assets to settle its liabilities as they fall due. These include the debt to total assets and times interest earned ratios and free cash flow. Supplies Consumable items used in running a business, such as office and cleaning supplies. Timeliness An enhancing qualitative characteristic of useful information that means that information is available to decision makers in time to be capable of influencing their decisions. Understandability An enhancing qualitative characteristic of useful information that means that information is clearly and concisely classified, characterized, and presented. Unearned revenue Cash received when a customer pays in advance of being provided with a service or product. It is received before revenue is earned and is therefore recorded as a liability until it is earned. Verifiability An enhancing qualitative characteristic of useful information that means that different knowledgeable and independent users could reach a consensus that the information is faithfully represented Working capital A measure of liquidity used to evaluate a company’s short-term debt-paying ability. It is calculated by subtracting current liabilities from current assets. CHAPTER 2 EQUATIONS Current liabilities = Accounts payable + Salaries payable + Unearned revenue. Shareholders’ equity = Common shares + Retained earnings. Total assets = Cash + Held for trading investments + Accounts receivable + Inventory + Prepaid rent + Supplies + Equipment – Accumulated depreciation + Intangible assets. Total liabilities = Accounts payable + Salaries payable + Unearned revenue + Long-term notes payable. CONCEPTUAL FRAMEWORK 1. Identify the sections of a classified statement of financial position. In a classified statement of financial position, assets are classified as current or non-current assets. In the non-current asset category, they are further classified as long-term investments; property, plant, and equipment; intangible assets and goodwill; or other assets. Liabilities are classified as either current or non-current. There is also a shareholders’ equity section, which shows share capital and retained earnings, and other equity items if any exist. 2. Identify and calculate ratios for analyzing a company’s liquidity, solvency, and profitability. Liquidity ratios, such as working capital and the current ratio, measure a company’s short-term ability to pay its maturing obligations and meet unexpected needs for cash. Solvency ratios, such as debt to total assets, measure a company’s ability to survive over a long period by having enough assets to settle its liabilities as they fall due. Profitability ratios, such as basic earnings per share and the price-earnings ratio, measure a company’s operating success for a specific period of time. 3. Describe the framework for the preparation and presentation of financial statements. The key components of the conceptual framework are (1) the objective of financial reporting; (2) qualitative characteristics of useful financial information, which include fundamental and enhancing characteristics and the cost constraint; (3) the going concern assumption underlying the accounting process; (4) elements of the financial statements; and (5) measurement of the elements of financial statemen
