C213 Study Guide - Solution PDF

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C213 Study Guide Solutions Table of Contents Chapter 1: Nature and Purpose of Accounting.................................................................1 Describe the purpose of accounting...........................................................................1 Describe the three financial statements.....................................................................1 Identify users of financial statements for a particular situation..................................1 Identify U.S. accounting rules and their origins..........................................................2 Differentiate the roles of important accreditation organizations.................................3 Describe current trends that are causing changes in the field of accounting............3 Chapter 2: Overview of Financial Statements..................................................................3 Identify the purposes of financial statements in specific situations............................3 Identify components of a balance sheet.....................................................................4 Use the accounting equation to calculate total assets, total liabilities, or total stockholders’ equity....................................................................................................5 Identify components of the income statement...........................................................5 Identify components of the cash flow statement........................................................6 Explain the purpose of notes to financial statements.................................................6 Describe the purpose of an external audit.................................................................7 Explain the concepts of comparability, conservatism, materiality, and articulation....7 Chapter 3: Introduction to Financial Statement Analysis..................................................8 Recognize the purpose of financial statement analysis and financial ratios..............8 Compute widely used financial ratios.........................................................................8 Interpret widely used financial ratios..........................................................................8 Calculate cash flow ratios for a given situation..........................................................8 Chapter 4: The Balance Sheet.......................................................................................12 Identify the order of assets, liabilities, and stockholders’ equity accounts on a balance sheet...........................................................................................................12 Record the proper values for items on a balance sheet in a particular situation.....14 Chapter 5: The Income Statement.................................................................................15 Describe the purpose of net income on an income statement.................................15 Prepare a simplified income statement....................................................................15 Explain when revenues and expenses are recognized for a particular situation.....15

Analyze the impact of revenue transactions on the expanded accounting equation and financial statements...........................................................................................16 Evaluate a historical income statement to forecast a future income statement.......16 Chapter 6: The Statement of Cash Flows......................................................................17 Describe the purpose of the statement of cash flows..............................................17 Identify the categories of a cash flow statement and cash flow activities included in each category...........................................................................................................17 Prepare a simplified statement of cash flows...........................................................18 Describe the differences between the direct and indirect methods of the cash flow statement..................................................................................................................19 Analyze a statement of cash flows to identify operating, investing, or financing activities....................................................................................................................19 Chapter 7: Cash Budgeting............................................................................................20 Evaluate a company’s credit policy..........................................................................20 Calculate cash collections from cash and credit sales based upon collection history. ..................................................................................................................................20 Calculate cash payments for disbursement based upon a company’s payment policy.........................................................................................................................21 Chapter 8: Internal Controls...........................................................................................22 Identify common financial statement errors.............................................................22 Recommend the proper internal controls to prevent accidental loss or intentional theft or fraud for a particular situation......................................................................22 Identify motivations and common techniques used to manage earnings................22 Explain the effect of the Sarbanes-Oxley Act on financial reporting........................23 Describe the role of auditors and their impact on the integrity of financial statements................................................................................................................24 Explain the role of the U.S. Securities and Exchange Commission (SEC) in financial reporting.....................................................................................................24 Chapter 9: Managerial Accounting and Cost Concepts.................................................25 Describe the purpose of management accounting..................................................25 Differentiate between management and financial accounting.................................25 Describe the differences between accounting in a manufacturing environment and a service environment..............................................................................................25 Define common terms and concepts used in management accounting..................26 Distinguish between product costs and period costs...............................................28

Describe the role of key ethical standards in the field of management accounting.28 Calculate the cost of a product.................................................................................28 Differentiate how the types of inventory affect calculations.....................................28 Explain the difference between job costing and product costing.............................28 Chapter 10: Activity-Based-Costing (ABC).....................................................................29 Compare and contrast traditional costing to activity-based costing (ABC)..............29 Identify categories of ABC activities and their related overhead costs....................29 Identify appropriate cost drivers for a particular situation........................................30 Compute overhead costs under an ABC system.....................................................31 Compute product costs under a traditional volume-based costing system.............32 Justify a decision about a selling price based on traditional volume-based costing or activity-based costing systems.................................................................................32 Chapter 11: Cost-Volume-Profit Analysis (C-V-P)..........................................................33 Describe cost-volume-profit analysis.......................................................................33 Describe how basic cost behavior patterns change as sales volumes change.......33 Apply cost-volume-profit analysis to demonstrate the effect of changes in variable costs, fixed costs, sales price, and sales volume on profit......................................33 Analyze a cost-volume-profit graph to determine the level of variable costs, fixed costs, break-even point, and profit...........................................................................35

Chapter 1: Nature and Purpose of Accounting Describe the purpose of accounting. Accounting is the recording of the day-to-day financial activities of a company and the organization of that information into summary reports used to evaluate the company's financial status. Bookkeeping is a part of accounting. Bookkeeping refers to the process of recording transactions into various accounts, which is the first step in accounting. The next step is to analyze the accounts and organize them into financial statements and other useful reports. (Reference topic 1.1) Describe the three financial statements. The balance sheet reports a company's assets, liabilities, and owners' equity. It reports the financial position of a firm at a point in time. The income statement reports the amount of net income earned by a company during a period. Net income is the excess of a company's revenues over its expenses. It reports the financial performance of a firm over a period of time. The statement of cash flows reports the amount of cash collected and paid out by a company in the following three types of activities: operating, investing, and financing over a period of time. (Reference topic 1.2) Identify users of financial statements for a particular situation. Lenders Banks use companies' financial statements in making decisions about commercial loans. The financial statements are useful because they help the lender predict the future ability of the borrower to repay the loan. Investors Investors want information to help them estimate how much cash they can expect to directly receive from the business in the future if they invest in it now. Company Management Managers use financial accounting data to formulate company goals, to compute bonuses for employees, and to illuminate company weaknesses. Suppliers and Customers Suppliers, customers, and employees use financial statements to tell them about the long-run prospects of a company. Employees 1

Financial statement data, as mentioned earlier, are used in determining employee bonuses. In addition, financial accounting information can help an employee evaluate the employer's ability to fulfill its long-run promises, such as for pensions and retiree health care benefits. Financial statements are also important in contract negotiations between labor and management. Competitors Competitors use financial accounting information to reveal strategic opportunities within their industry. Government Agencies Government agencies use financial statement data to bolster political and regulatory positions for and against companies. Politicians Politicians use financial statement data to bolster political and regulatory positions for and against companies. The Press Reporters use financial accounting data as background information and to indicate which companies are undergoing significant changes in financial status. (Reference Topic 1.3) Identify U.S. accounting rules and their origins. The Financial Accountings Standards Board (FASB) sets accounting rules for the private section in the U.S.. It is a private, non-profit body established and supported by the joint efforts of the U.S. business community, financial analysts, and practicing accountants. The FASB has no legal power to enforce the accounting standards it sets but maintains its influence by carefully protecting its prestige and reputation. The standards it sets are called Generally Accepted Accounting Standards (GAAP). These are a common set of accounting principles, standards, and procedures that companies must follow when they compile their financial statements. (Reference Topic 1.4) Securities and Exchange Commission (SEC) has the legal authority to set accounting rules, but has deferred that responsibility to the FASB in most cases. The SEC regulates U.S. stock exchanges and seeks to create a fair information environment in which investors can buy and sell stocks without fear that companies who sell stocks to the general public are hiding or manipulating financial data. (Reference topic 1.5)

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Differentiate the roles of important accreditation organizations. CPA Accreditation - The American Institute of Certified Public Accountants (AICPA) is the professional organization of certified public accountants (CPAs) in the United States. A CPA is someone who has taken a minimum number of college-level accounting classes, has passed the CPA exam, and has met other requirements set by his or her state. A CPA firm is a company that provides freelance business advice, particularly in connection with accounting issues and executes the vast majority of external audits in the US. The AICPA sets ethical standards for CPAs, provides continuing education for them, writes and grades the CPA exam, lobbies for legislation favored by CPAs, and provides other support to CPAs. Its oversight of the CPA exam is its main role in accreditation. However, to be accredited as a CPA you must meet the requirements of the state in which you plan to practice. The requirements for each state are set by that state’s legislature and overseen by that state’s Board of Accountancy, which is a state agency. (Reference Topic 1.5) Public Company Accounting Oversight Board (PCAOB) – The PCAOB determines who can audit public companies regardless of whether the audit firm is accredited by a state Board of Accountancy. Thus, they accredit firms that can audit public companies. Describe current trends that are causing changes in the field of accounting. Globalization – As more and more business do business globally, capital flows more freely across national boundaries. This means investors can choose to invest in firms all over the planet. To help them make investment decisions, the global accounting and regulatory communities are working to bring accounting standards around the world into agreement the IASB was one step in that direction, but nations still control the accounting standards used within their borders and so much of the standardization is being done through voluntary cooperation Technology – Information technology has speeded up the pace with which accounting data and reports are produced and dramatically increased the volume of accounting information that firms can provide to investors. (Reference Topic 1.6)

Chapter 2: Overview of Financial Statements Identify the purposes of financial statements in specific situations. The main different uses of financial statements depends on how different users use them. Here is a list of the major users and how their use of financial statements differs. Lenders 3

Banks use companies' financial statements in making decisions about commercial loans. The financial statements are useful because they help the lender predict the future ability of the borrower to repay the loan. Investors Investors want information to help them estimate how much cash they can expect to directly receive from the business in the future if they invest in it now. Company Management Managers use financial accounting data to formulate company goals, to compute bonuses for employees, and to illuminate company weaknesses. Suppliers and Customers Suppliers, customers, and employees use financial statements to tell them about the long-run prospects of a company. Employees Financial statement data, as mentioned earlier, are used in determining employee bonuses. In addition, financial accounting information can help an employee evaluate the employer's ability to fulfill its long-run promises, such as for pensions and retiree health care benefits. Financial statements are also important in contract negotiations between labor and management. Competitors Competitors use financial accounting information to reveal strategic opportunities within their industry. Government Agencies Government agencies use financial statement data to bolster political and regulatory positions for and against companies. Politicians Politicians use financial statement data to bolster political and regulatory positions for and against companies. The Press Reporters use financial accounting data as background information and to indicate which companies are undergoing significant changes in financial status. (Reference Topic 1.3) Identify components of a balance sheet. The three main sections of the Balance Sheet are Assets, Liabilities, and Equity. Both assets and liabilities are further separated into current and long term based on whether the asset is expected to be consumed or the liability paid within a year. Assets 4

expected to be consumed and liabilities expected to be paid within a year are current and those that will be consumed or paid after a year are long-term. Equity is separated into paid in capital (also referred to as capital stock) and retained earnings. Paid in capital is created when an owner buys stock from the firm. Retained earnings are the accumulated earnings of the firm (i.e., net income over time) that have not been paid back in dividends. Paid in capital also is referred to as contributed capital while retained earnings is earned capital. Use the accounting equation to calculate total assets, total liabilities, or total stockholders’ equity. The Balance Sheet equation: Assets = Liabilities + Equity. Given values for any two of the three components you can always calculate to third component using this equation. For example, if you know a firm’s total assets and liabilities, you can calculate owners’ equity by: Assets – Liabilities = Equity Identify components of the income statement. The Income Statement describes a company’s financial performance for a period of time. A company's expenses are subtracted from its revenues and gains and losses are also factored in computing net income. Net income helps explain the change in retained earnings between two Balance Sheet dates, along with dividends and unrealized gains and losses. A single step income statement lumps all revenues together and subtracts all expenses to calculate net income. A multiple-step presents subtotals that highlight key performance measures. Its categories include: Sales or revenues - Cost of goods sold (COGS) (Product costs of items sold) = Gross profit - Selling and Administrative expenses (also called operating expenses) = Operating income or earnings before interest and taxes (EBIT) + Other income - other expenses + gains - losses = Earnings before taxes (EBT) - Taxes = Net Income (Profit) If the firm has experienced a discontinued operation or extraordinary item, the effects of these events are subtracted from all the income statement line items and the income statement will include another subtotal – income from continuing operations that will be 5

followed by a single line item that presents to effects of the extraordinary item discontinued operations and then net income. Identify components of the cash flow statement. The Statement of Cash Flows details how a company obtained and spent cash during a certain period of time. Thus, the cash flow statement explains the change in the firm’s cash account for a period of time. All of a company's cash transactions are categorized as either operating, investing, or financing activities. i) Operating cash flows are those associate with any activity on the income statement. The operating section of the cash flow statement is what the income statement would show if the income statement were prepared on a cash basis and not accrual basis. ii) Investing cash flow are those related to a firm investing in itself (purchasing and selling property, plant and equipment or other businesses) and investing in others (buying the stocks and bonds of another firm or lending another firm money). iii) Financing cash flows are those associated with someone investing in your firm, either stockholders (buying and selling your sto...