Acct Chapter 2 Study Guide PDF

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Summary

Course is taught by Janice Holmes as an introductory course into financial accounting, required to be take by all Business majors....

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Chapter 2: A Further Look at the Financial Statements Study Guide (Note: This worksheet is intended as an optional study guide. Do not submit to the instructor.) Learning Objectives: 1. Identify the sections of a classified balance sheet. 2. Identify tools for analyzing financial statements and ratios for computing a company’s profitability. 3. OMIT (Pages 56-57): Explain the relationship between a retained earnings statement and a statement of stockholders’ equity. 4. Identify and compute ratios for analyzing a company’s liquidity and solvency using a balance sheet. 5. OMIT (Page 61): Use the statement of cash flows to evaluate solvency. 6. Explain the meaning of generally accepted accounting principles. 7. Discuss financial reporting concepts. LO 1:

1. Define Classified Balance Sheet: 

A balance sheet that groups together similar assets and similar liabilities, using a number of standard classifications and sections



This is useful because items within a group have similar economic characteristics.

2. Standard classifications of Classified Balance Sheet: Assets

Liabilities & Stockholders’ Equity

Current assets

Current liabilities

Long-term investments

Long-term liabilities

Property, plant, and equipment

Stockholders’ equity

Intangible assets

3. Define the following:

Current Assets

Definition

Examples

Assets that a company expects to convert to cash or use up within one year or its operating cycle, whichever is longer

Cash, investments (such as short-term U.S. government securities), receivables (accounts receivable, notes receivable), inventories, prepaid expenses (insurance and supplies)

Note: Current Assets are listed on the Balance Sheet in the order when they are expected to be converted into cash. (Order of liquidity)

ACCT 2001: Ch. 02

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For most businesses, this cycle takes 1 year or less. But for some businesses, such as vineyards, this period may be longer. Except where noted, assume 1 year.

Operating Cycle

The average time required to go from cash to cash in producing revenue – to purchase inventory, sell it on account, and then collect cash from customers

Long-term Investments

Generally: (1) investments in stocks and bonds of other corporations that are held for more than 1 year; (2) long-term assets such as land or buildings that are not currently used in operating activities; (3) longterm notes receivable

Property, Plant, & Equipment

Assets with relatively long useful lives that are currently used in operating the business

Depreciation

The allocation of the cost of an asset to a number of years

Accumulated Depreciation

Account that shows the total amount of depreciation that the company has expensed thus far in an asset’s life

Book Value

Value of an item as listed on For an asset, Book the company’s books Value = original cost – accumulated depreciation

Intangible Assets

Assets that do not have physical substance

Goodwill, patents, copyrights, trademarks, etc.

Current Liabilities

Obligations that the company is to pay within the next year or operating cycle, whichever is longer

Accounts payable, salaries and wages payable, notes payable, interest payable

Long-Term Liabilities

(long-term debt) Obligations that a company expects to pay after one year

Bonds payable, longterm notes payable, lease liabilities, pension liabilities

ACCT 2001: Ch. 01

Land, buildings, equipment, delivery vehicles, furniture, etc.

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LO 2: LO 4:

Stockholders’ Equity

The owners’ claim to assets

Common Stock

The investments of assets into the business by the stockholders

Retained Earnings

The income retained for use in the business

Common stock and retained earnings

4. Ratio Analysis:  Ratio analysis: a technique that expresses the relationship among selected items of financial statement data



A ratio: an expression of the mathematical relationship between one quantity and another

5. 3 Types of Ratios: Type

Purpose

Examples

Profitability Ratio

Measures the income or operating success of a company for a given period of time

Earnings per share

Liquidity Ratio

Measures the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash

Working capital, current ratio

Solvency Ratio

Measures the ability of the company to survive over a period of time

Debt to assets ratio

ACCT 2001: Ch. 01

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6. Define the following ratios and write the formula: 

Earnings per Share (EPS) – a measure of the net income earned on each share of common stock. Computed as: ____________Net Income – Preferred Stock Dividends____________ Average Number of Common Shares Outstanding During the Year



Working Capital – the difference between the amounts of current assets and current liabilities. Computed as: Current Assets – Current Liabilities



Current Ratio – a measure of liquidity computed as current assets divided by current liabilities. Computed as: __Current Assets__ Current Liabilities



Debt to Total Assets Ratios – a measure of solvency calculated as total liabilities divided by total assets. It measures the percentage of total financing provided by creditors rather than stockholders. Computed as: _Total Liabilities_ Total Assets

LO 6:

7. Define Generally Accepted Accounting Principles (GAAP): A set of accounting standards that have substantial authoritative support, that guide accounting professionals 8. Standard-setting Bodies

ACCT 2001: Ch. 01

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Definition Securities and Exchange Commission (SEC)

The agency of the U.S. government that oversees U.S. financial markets and accounting standard-setting bodies

Financial Accounting Standards Board (FASB)

The primary accounting standard-setting body in the United States

International Accounting Standards Board (IASB)

An accounting standard-setting body that issues standards adopted by many countries outside of the U.S.

Public Company Accounting Oversight Board (PCAOB)

The group charged with determining auditing standards and reviewing the performance of auditing firms

9. 2 fundamental qualities of useful information: ACCT 2001: Ch. 01

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Quality

Definition

Relevance

The quality of information that indicates the information makes a difference in a decision

Faithful Representation

Information that is complete, neutral, and free from error

ACCT 2001: Ch. 01

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10. Enhancing Qualities of Useful Information: Qualities

Definition

1. Comparability

Ability to compare the accounting information of different companies because they use the same accounting principles

2. Consistency

Use of the same accounting principles and methods from year to year within a company

3. Verifiability

The quality of information that occurs when independent observers, using the same methods, obtain similar results

4. Timeliness

Information that is available to decision-makers before it loses is capacity to influence decisions

5. Understandability

Information presented in a clear and concise fashion so that users can interpret it and comprehend its meaning

11. Assumptions in Financial Reporting Assumptions

Definition

1. Monetary Unit Assumption

An assumption that requires that only those things that can be expressed in money are included in the accounting records

2. Economic Entity Assumption

An assumption that every economic entity can be separately identified and accounted for

3. Periodicity Assumption

An assumption that the life of a business can divided into artificial time periods and that useful reports covering those periods can be prepared for the business

4. Going Concern Assumption

The assumption that the company will continue in operation for the foreseeable future

12. Principles in Financial Reporting Qualities

Definition

1. Historical Cost Principle

Dictates that companies should record assets at their cost

2. Fair Value Principle

States that assets and liabilities should be reported at fair value (the price received to sell an asset or settle a liability)

3. Full Disclosure Principle

Dictates that companies disclose circumstances and events that make a difference to financial statement users.

ACCT 2001: Ch. 01

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13. Cost Constraint: Constraint that weighs the cost that companies will incur to provide the information against the benefit that financial statement users will gain from having the information available

14. Know the definitions listed in the Glossary at the end of the chapter.

ACCT 2001: Ch. 01

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