Intro to Financial Accounting notes PDF

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Detailed notes for chapters 1-13 including necessary appendixes for professor Sarah O'Rourke...

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❖ FINAL EXAM SUNDAY DECEMBER 22 10am-1pm ❖ 9/3/19 notes ❖ Sarbanes-oxley act ➢ Congress steps in and said companies have to put internal control in place to prevent fraud from occurring ➢ Have multiple people reassure numbers and only certain people get access to info ➢ Created a lot of extra work but was effective ❖ Enron ➢ Loans and debts they hid, did not show financials ➢ Whistleblower- somebody reported it ❖ Worldcom ➢ Created false revenue and income, hid expensives, gave picture company better off than it was ➢ People invested in a failing company ❖ Any publicly traded company has to follow GAAP due to ➢ Information not being subjective and so it’s clear to all ➢ Gives best possible way to look at the company ❖ FASB- independent standard setting body that makes up the rules ❖ SEC- gov’t body that oversees financial market, companies file quarterly report with SEC ❖ IASB- in US follow American accounting standard if in US ❖ Historical cost principle- what you paid for something ❖ Fair value principle- what someone would pay for it today ❖ reporting at fair value since it’s more relevant, but too subjective in financial terms ❖ In general, historical cost should be reported since reliable and more objective, already established, don’t want room for manipulation ❖ Monetary unit assumption- can only report things that can be quantified in dollars and cents ❖ Economic entity assumption- every business has its own records and should not be mixed with owner’s expenses and entities ❖ Proprietorship- typical small business, owner and manager the same, simple ❖ Partnership- same thing as above but with multiple people, full liability as well ❖ Corporation- limited liability and can’t go for personal assets, can easily transfer ownership through stocks for example, subject to higher taxes and more laws ❖ Basic accounting equation ➢ assets= liabilities + stockholder’s equity ➢ Assets ■ Things business owns ■ Resources ➢ Liabilities

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■ Debt, electric bill, owed money, salaries, borrowed money ➢ Stockholder’s equity ■ Owner’s claim on the assets of the company ■ Broken into common stock and retained earnings ■ Investments by stockholders and revenues increase stockholder’s equity ■ Expenses and dividends to stockholders decrease stockholder’s equity 9/5/19 notes Transactions ➢ Not necessarily just cash coming and going ➢ If can quantify in dollars and cents need to record as transaction ➢ Every transaction has dual impact ➢ May be external or internal Income statement ➢ Tells us about activity for a period of time ➢ Revenue, expenses and profitability ➢ Shows net income Retained earnings statement ➢ Net income less dividends ➢ Do income statement first since need net income for retained earnings Balance sheet ➢ Show assets= liability and stockholder’s equity Statement of cash flows ➢ Need balance sheet and income statement

9/10/19 Notes Chapter 2 The Recording Process ❖ Account- show all activity for period and balance at the end ➢ Debit and Credit doesn’t mean increase or decrease ➢ Debit = left ➢ Credit = right ❖ Double entry system ➢ Debits must equal credits ➢ Must keep basic accounting equation in balance ❖ If the sum of debit entries are greater than the sum of credit entries, the account will have a debit balance ❖ If the sum of credit entries are greater than the sum of debit entries, the account will have a credit balance ❖ Normal balance Debit ➢ Assets ➢ Expenses

➢ dividends ❖ Normal Balance Credit ➢ Liabilities ➢ Stockholder’s equity ➢ Revenues ❖ Left side of equation has debits increase and credits decrease ❖ Right side of equation has debits decrease and credits increase except for dividends and expenses ❖ Side that increases = normal balance 1. Service Revenue = Credit 2. Rent Expense = Debit 3. Accounts Receivable = Debit 4. Accounts Payable = Credit 5. Common Stock = Credit 6. Office Supplies = Debit 7. Insurance Expense = Debit 8. Dividends = Debit 9. Office Building = Debit 10. Notes Payable = Credit 11. Cash = Debit ❖ Account payable- get some time to pay like a couple weeks, informal kinda ❖ Notes payable- more formal, get longer time to pay such as 3-6 months, charge interest and in writing ❖ Journal Entries ➢ General journal- book of original entry ➢ Chronological listing of all transactions w/ complete details throughout the month ➢ Shows complete effect of a transaction ❖ The Ledger ➢ Collection of all the accounts ➢ Each type of expense gets its own account ➢ Called the general ledger ➢ Similar to t-account but more specific ❖ Posting ➢ Transferring journal entries to the ledger accounts ❖ Chart of accounts ➢ Lists all the different accounts and their assigned numbers to prevent redundancy ❖ Preparing a trial balance ➢ Quick report, not formal ➢ Even if balanced, doesn’t mean there are not mistakes

➢ Helps you catch some mistakes 9/17/19 notes Chapter 3 Adjusting the Accounts ❖ Cash basis- everyday people, won’t tell you a lot about cash going out over time ❖ Accrual basis- provides better info, GAAP requires it, tells you how much you used in expenses each quarter rather than deducting cash for all the supplies in the first quarter ❖ Time period assumption- can break business down into artificial time periods, means by which to organize info ❖ Calendar year- jan 1 to dec 31 ❖ Fiscal year- any year long period, doesn’t have to start jan 1st ❖ Interim periods- monthly and quarterly time periods ❖ Cash basis accounting ➢ Don’t use under GAAP ➢ Revenues are recorded when cash is received ➢ Expenses are recorded when cash is paid ❖ Accrual-basis accounting ➢ Transactions recorded in the periods in which the events occur ➢ Revenues recognized when they perform services ➢ Expenses recognized when incurred ➢ Revenue recognized when the performance obligation is satisfied ➢ Expenses recognized when the company makes effort to generate those revenues ❖ Adjusting entries ➢ 4 types (first 2 are deferrals and last 2 are accruals) ■ Prepaid expenses ● Expenses paid in cash before they are used or consumed, report initially as asset ■ Unearned revenues ● Cash received before services are performed ● Someone prepaid a service, but it has not been earned, account is a liability ● Once do service, can classify and show as revenue on income statement ■ Accrued revenues ● Revenues for services performed but not yet received in cash or recorded, work happened but not paid yet or officially billed yet ■ Accrued expenses ● Expenses incurred but not yet paid in cash or recorded ❖ Trial balance ➢ Take all the accounts and write out their debit or credit to see overall debit and credit

➢ Probably needs to be adjusted ❖ 9/19/19 notes ➢ Relevance ■ a piece of accounting info that would make a difference in a business decision ■ Has confirmatory value- confirm something that was predicted beforehand ■ Predictive value- helps make decision where company is going down the line ➢ Faithful representation- straightforward info that is not bias and free from error ➢ Materiality- item that is likely to influence the decision of an investor or creditor ➢ Comparability- able to compare different companies ➢ Verifiable- someone else is able to come up with the same number for items ➢ Understandability- info should be in clear and concise fashion ➢ must be timely for info to have relevance ➢ Full disclosure principle- disclose circumstances that would make a difference to financial statement users ➢ Cost constraint- costs to gather info and release it vs benefits of doing it ❖ 9/24/19 notes Chapter 4: Completing the Accounting Cycle ➢ Closing entries after financial statement preparation ➢ Want to close out temporary accounts so they have zero balance for new period ➢ Net income and dividends are closed to retained earnings ➢ Net income= revenue - expenses ➢ Retained earnings= beg + net income - dividends= end ➢ 4 basic closing entries ➢ General ledger- collection of all the accounts ➢ General journal- listing all the transactions in chronological order ➢ Correcting entries- can avoid extra step by using it ❖ 9/26/19 notes exam, 25-30 MC, suggested hw problems are recommended, self-test mc at end of chapter ➢ Classified balance sheet- presents a snapshot at a point in time ➢ Liabilities broken up by how long till you have to pay ➢ 4 types of assets: ■ Current assets- assets that company can expect to turn to cash. Accounts receivable, prepaid insurance, stuff that can be converted within a year ● Cash, short term investments, a/r, inventories, prepaid expenses and other current assets ● Listed in order they ex pect to convert them into cash ● Compare to current liabilities since shows risk of whether worth it or not to buy stock

■ Long term investments ● Investments in stocks and bonds of other companies ● Not getting cash back within a year ● Long term notes receivable ■ Property plant and equipment ● Long useful lives ● Currently used in operations ● Assets that are used within the business, don’t plan to sell to anyone else ● Depreciation and accumulated depreciation ■ Intangible assets ● Long lived assets that don’t have physical substance ● Goodwill- loyal customer base, loyal employees, the value of that ➢ Liabilities: 2 types ■ Current liabilities ● Obligations the company has to pay within the coming year or operating cycle, whichever is longer ● Usually list notes payable first, followed by accounts payable, others follow in order of magnitude ● a/p, salaries payable, notes payable, interest payable, income taxes payable, current maturities of long term debt (partial payment of long term loan) ● Liquidity- ability to pay obligations expected to be due within the next year ● Notes payable- formal, less than a year, written, pay interest ● Accounts payable- informal, flexible due date ■ Long term liabilities ● Obligation a company expects to pay after one year ● Bonds payable, notes payable, deferred income tax and other ● Bond- company looking for a loan ➢ Stockholders’ equity ■ Proprietorship- one capital account ■ Partnership- capital account for each partner ■ Corporation- common stock and retained earnings ❖ 10/08/19 notes EXAM 2 material ❖ Chapter 5 notes ➢ Merchandising companies buy and sell goods ➢ Operating service of merchandising company usually longer than that of a service company

➢ Cost of goods sold= total cost of merchandise sold during the period ➢ Gross profit- profit on inventory alone ➢ Use either a perpetual inventory system or a periodic inventory system to account for inventory ➢ Perpetual system ■ Each sale keeps track of the cost of each good sold ■ Provides better control on inventory since at any point in time know how much inventory you have ➢ Periodic system ■ Not detailed records of good sold ■ Counts inventory at beginning and end to find out cost of goods sold ■ Can be a problem since don’t know how inventory leaving the store, could be stolen ■ Relying on the count to find cost of goods sold, but nothing to compare too ➢ Advantages of perpetual ■ Shows at any point in time where you stand ■ Have something to compare to unlike periodic system ➢ Normally record when goods are received from seller ➢ Freight costs ■ Important to specify who owns the goods when it’s on the trucks ■ FOB shipping point- If buyer owns it on truck, buyer pays shipping ■ FOB destination- If seller owns it on truck, seller pays shipping ■ Freight costs incurred by the seller are an operating expense ■ If buyer pays shipping, debit inventory, not an expense, added to cost of asset ■ If seller pays, debit freight-out or shipping expense ➢ Purchase returns and allowances ■ Purchaser could send goods back if not up to par ■ Purchase return- return goods for credit if the sale was made on credit or for cash refund if bought for cash ■ Purchase allowance- keep goods if seller grant reduction from purchase price ➢ Purchase discounts ■ Credit terms may permit buyer to claim a cash discount for prompt payment ■ Saves purchaser money ■ Seller shortens the operating cycle by converting the A/R into cash earlier ❖ 10/10/19 notes

➢ Record sales under a perpetual inventory system ➢ Sales revenue recorded when obligation is satisfied ➢ Performance obligation satisfied when the goods are transferred from seller to buyer ➢ Journal entries to record a sale ■ Debit: cash or a/r (what customer paid to you) ● Credit: sales revenue ■ Debit: cost of goods sold- (what you paid) (account is an expense) ● Credit: inventory ➢ Sales returns and allowances (name of account) ■ “Flip side” of purchase returns and allowances ■ Contra-revenue account to sales revenue (debit) ■ Sales not reduced (debited) because ● Would obscure importance of sales returns and allowances as a percentage of sales ● Could distort comparisons ■ If goods are worthless, don’t add back to inventory and don’t adjust cost of goods sold ■ For allowances, don’t need to adjust inventory or COGS ➢ Sales discount ■ Offered to customers to promote prompt payment of the balance due ■ Contra-revenue account (debit) to sales revenue ➢ Net Sales= sales revenue- sales returns and allowances- sales discounts ➢ Adjusting entries ■ Generally the same as a service company ■ One additional adjustment to make the records agree with the actual inventory on hand ■ Involves adjusting inventory and cost of goods sold ■ Debit COGS and credit Inventory if physical account less than unadjusted balance ➢ Multi-step income statement for non-service company ■ Distinguishes between operating and non-operating activities ■ Several steps to find net income ■ Net sales ■ Gross profit= net sales- COGS ■ Operating expenses ■ Non-operating activities ■ Net income ➢ Single step

■ Companys does not realize any profit until total revenues exceed total expenses ❖ 10/15/19 notes ❖ Chapter 6 notes: Inventories ➢ Taking a physical inventory ■ Companies take inventory ● when the business is closed or business is slow ● At the end of the accounting period ➢ Audit- purpose is to see that inventory is legit, can’t take word for it ➢ Determining ownership of goods ■ Goods in transit ● Purchased goods not yet received ● Sold goods not yet delivered ■ Goods in transit should be included in the inventory of the company that has legal title to the goods. Legal title is determined by the terms of sale ■ FOB shipping point- ownership passes to the buyer when the public carrier accepts the goods from the seller ■ FOB destination- ownership of the goods remains with the seller until the goods reach the buyer ➢ Consigned goods ■ To hold the goods of others parties and try to sell the goods for them for a fee, but don’t take ownership of the goods ➢ Inventory is accounted for at cost ➢ Cost includes all expenditures necessary to acquire goods and place them in a condition ready for sale ➢ Cost flow assumptions ■ Inventory costing ■ Specific identification ● Actual physical flow costing method in which items still in inventory are specifically cost to arrive at the total cost of the ending inventory ● Practice is relatively rare ● Most companies make assumptions (cost flow assumptions) about which units were sold ■ Cost flow assumptions do not need to be consistent with the physical movement of goods ■ Beginning inventory + purchases - ending inventory= COGS ■ FIFO ● First in, first out

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● Costs of the earliest goods purchased are the first to be recognized in determining COGS ● Often parallels actual physical flow of merchandise ● Companies determine the cost of the ending inventory by taking the unit cost of the most recent purchase and working backward until all units of inventory have been costed ● LISH LIFO ● Last in, first out ● Costs of the latest goods purchased are the first to be recognized in determining costs of goods sold ● Seldom coincides with actual physical flow of merchandise ● Expectations include goods stored in piles, such as coal or hay ● Opposite of FIFO ● FISH Average cost ● Allocates cost of goods available for sale on the basis of weighted-average unit cost incurred ● Applies weighted-average unit cost to the units on hand to determine the cost of the ending inventory Total cost / # of units = average cost Methods should be used consistently, enhances comparability Although consistency is preferred, a company may change its inventory cost method Sales revenue always stays constant regardless of method

■ ❖ 10/22/19 notes ➢ FIFO reflects the inventory that has the most recent cost ➢ LIFO costs allocated to inventory may be understated in terms of current cost ➢ LIFO tends to give the lowest income taxes due to lower net income during times of rising prices ➢ Inventory errors on the financial statements ■ Due to wrong inventory count, not properly recognizing the transfer of legal title to goods in transit, errors affect income statement and balance sheet ■ Beginning inventory plus purchases = cost of goods available for sale ■ Cogafs- ending inventory= cogs ■ Combined income for 2 year period corrects itself ■ revenue - cogs = gross profit

➢ Income statement should disclose vital info on how inventory number on balance sheet was came up with ➢ Lower of cost or net realizable value (fair value) ■ When the value of inventory is lower than its cost ■ Companies must write down the inventory to its net realizable value ■ Net realizable value: amount that a company expects to realize (receive from the sale of inventory) ■ Example of conservatism ➢ Analysis- inventory management ■ High inventory levels- may incur high carrying costs (ex. Investment, storage, insurance, obsolescence, and damage) ■ Low inventory levels- may lead to stock outs and lost sales ■ Inventory turnover= cogs/ avg inventory ■ Days in inventory= days in year (365) / inventory turnover, tells us how many days to move inventory out the door ➢ Appendix 6b- 2 methods of estimating inventories ■ Gross profit method- method of estimating the cost of ending inventory by applying a gross profit rate to net sales ■ Need net sales, cogafs, gross profit rate (gross profit/sales revenue) ■ Net sales - estimated gross profit = estimated cogs ■ Cogafs - estimated cogs = estimated cost of ending inventory ■ Retail inventory method - on ppt ■ Major disadvantage of the retail method is that it is an averaging technique. It may produce an incorrect inventory valuation if the mix of the ending inventory is not representative of the mix in the goods available for sale. ❖ Chapter 7 notes: Fraud, Internal control and Cash ➢ Fraud- dishonest act by an employee that results in personal benefit to the employee at a cost to the employer ➢ Three factors contribute to fraud- opportunity, financial pressure, rationalization ➢ Sarbanes-oxley act- public companies have to put procedures in place to prevent fraud ➢ Internal control ■ 1. Safeguard assets ■ 2. Enhance the reliability of accounting records ■ 3. Increase efficiency of operations ■ 4. Ensure compliance with laws and regulations ➢ 5 components: a control environment (won’t penalize someone who speaks up), risk assessment (where would fraud most likely occur), control activities

(measures in place to prevent fraud), info and communication ( give feedback on controls in place), monitoring (always updating and assessing that controls r working) ➢ 6 Principles of internal control activities ■ Establishment of responsibility ● Control is most effective when only one person is responsible for a given task ● Establishing responsibility often requires limiting access only to authorized personnel and then identifying those personnel ■ Segregation of duties ● Different individuals should be responsible for related activities ● The responsibility for record keeping for an asset should be separate from the physical custody of that asset ● In regard to full process ❖ 10/24/19 notes ■ Documentation procedures ● Companies should use prenumbered documents, and all documents should be accounted for ● Employees should promptly forward source documents for accounting entries to the accounting department ■ Physical controls ● Garment sensors ● Safes, vaults ● Alarms ● Time clocks ● Pass key access or fingerprints ● Locked warehouses and storage cabinets for inventories and records ■ Independent internal verification ● Rec...