Study Guide Covering Chapters 1-3 Purpose: The purpose of this study guide is to give you a condensed overview of the material covered in class, paying particular attention towards formulas and rules. This does NOT replace the necessity for reading the text, and referring to notes. . . it is simply to have very important concepts in one, easy to find place. Chapter 1 – A Review We were introduced here to the 4 basic Financial Statements: Income Statement, Retained Earnings Statement, Balance Sheet, and Statement of Cash Flows. Obviously, you must know what makes up these statements, so, here are the formulas that make up each one. Income Statement: Revenues – Expenses = Net Income - Net income is needed for the Retained Earnings Statement. Retained Earnings Statement: Beginning RE + Net income – Dividends = Ending RE - Ending Retained Earnings is needed for the balance sheet - A company that has just started, and therefore has no prior earnings, has a beginning retained earnings of “0”. Balance Sheet: Assets = Liabilities + Stockholders’ Equity - Or, Assets = Liabilities + Common stock + Retained Earnings - Or, Assets = Liabilities + Common Stock + Revenues – Expenses – Dividends Statement of Cash Flows: - There isn’t a formula, but the format is to add Cash Flows from Operating, Investing, and Financing Activities and then add cash from the beginning of the period to get the Cash at the end of the period. Primary Forms of Business Organization 1.) Sole Proprietorship – one owner 2.) Partnership – two owners, shared liability 3.) Corporation – Publicly traded and owned business. Corporations are separate legal entities.The Difference between Internal Users and External Users and how they use accounting: 1.) internal users are managers who use accounting practices to plan, organize, and run business operations. 2.) External users are stockholders and creditors whom use the financial statements provided by companies to decide whether to invest, or extend loans to them. What is an asset? What is a liability? 1.) asset – resources owned by a business. Ex. Supplies 2.) liabilities – the debts and obligations a business owes. Ex. Loans extended to the business ** Above all – the most important aspect of Chapter one is the introduction of the Basic Accounting Equation: Assets = Liabilities + Stockholders’ Equity everything we have done so far comes from this equation. It’s importance can’t be overstated. Chapter 2: A Review We were introduced to the concept of a classified balance sheet which classifies assets further than we had before. Assets were categorized as Current Assets; long-term investments; property, plant, equipment; and intangibles. We were also introduced to methods of calculating a company’s worth and profitability: Liquidity is a business’s ability to pay obligations expected to become due within the next year or business cycle. We calculate liquidity using: Working Capital: Current Assets – Current Liabilities Current Ratio: Current Assets/Current Liabilities Solvency is a business’s ability to pay interest as it comes due and to repay the balance of a debt due at its maturity. We calculate liquidity using: Debt to Assets Ratio: Total Liabilities/Total AssetsEarnings Per Share measures the net income earned on each share of common stock. Earnings Per Share = Net income – preferred dividends / avg. # shares outstanding during the year. These types of calculations we did extensively in class. However, that’s not all that chapter two had to offer. Referring back to the purpose of this study guide, I would consult the notes for more important information chapter 2 offered. Also, WileyPlus offers ample resources for practice and studying including Flashcards. Chapter 3: A Review Here we were introduced to the dreaded concept of debits and credits. In fact, the concept is so overwhelmingly important in Chapter 3 and for the rest of this course that this review is going to be dominated by the explanation of debits and credits. So, here we go! To begin the explanation of debits and credits, we must first understand what exactly an account is. An account is an individual accounting record of increases and decreases in a specific asset, liability, stockholders’ equity, revenue, or expense item. For our purposes, an account consists of 3 parts: (1) the title of the account, (2) a left side or debit side, and (3) a right or credit side. Debits and credits do not mean increase or decrease, instead, when entering an amount on the left side of an account you are said to be debiting the account, and when entering an amount on the right side of an account you are said to be crediting the account.If an account has a debit that exceeds credits, then the account is said to have a debit balance, and the same for the credit side. Each transaction must affect two or more accounts to keep the basic accounting equation in balance. In other words, for each transaction, debits must equal credits. Remember this chart from the text: Okay, let’s look at a couple of examples so we can better understand debits and credits. 1.) On October 1st, Sierra Inc. borrows cash of $5,000 by signing a 3-month, 12%, $5,000 note payable. Here we have two accounts being affected: Cash, and notes payable. Cash is an asset, and notes payable is a liability. According to the chart above, to increase an asset we debit it, and to increase a liability we credit it. So, now we know that we have to debit the cash account for $5,000 and we have to credit the notes payable account for $5,000. This keeps the accounting equation in balance because whatever we’ve done to assets, we done to liabilities. Now, we have to show this transaction in account form. ___Cash___ __Notes Payable__ $5,000/ / $5,0002.) On October 2nd, Sierra Inc. used $5,000 cash to purchase equipment Here, the two accounts we have affected is cash and equipment. Both are assets, but one must be debited to increase it, and one must be credited to decrease it because according to the chart above, debiting an asset increases it and crediting an asset decreases it. So, now we know that cash must be credited $5,000 because we are using it to purchase equipment. We also know now that equipment must be debited $5,000 because we are increasing that asset. Now, all we have to do is show this in account form. ___Cash____
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