ACG3101 Exam 1 Study Guide (Chapters 1-4)Chapter 1—Environment and theoretical structure of financial accounting- Primary focus of financial accounting is on the information needs of investorsand creditors to help them predict future cash flows- Corporations acquire capital from investors (in exchange for ownership) and creditors (by borrowing)- Cash receipts must > cash disbursements to provide a return to investors andcreditors- Shareholders receive cash from dividends and sales of stock- Creditors receive cash from interest payments and repayment of principle (loans)- Cash basis—revenues and expenses are recognized when cash is received and paid—can show how much cash a company has at a time, but may not be accurate predictor of future operating cash flowso This is why for the accrual method, they have the SCF- Accrual accounting NI is considered a better indicator of future operating cash flows- Congress sets standards for accounting but has always delegated to accounting profession- The SEC had the authority to set accounting standards for publicly traded companies- Financial accounting standards board (FASB) sets the rules for accounting standards (GAAP)- Auditors serve as independent intermediaries to help ensure that management has appropriately applied U.S. GAAP in preparing companies financial statements- Goal of Sarbanes-Oxley—restore credibility in financial reporting process- The overriding objective of fundamental qualitative characteristics of accounting info is DECISION USEFULNESSo Useful information—relevance & faithful representationo Relevance—predictive value, confirmatory value, & materiality o Faithful representation—completeness, neutrality, & free from erroro Enhancing qualities—comparability, verifiability, timeliness, understandability, o Key constraint: cost effectiveness—cost vs. benefits- An item should be recognized in the financial statements when it meets four criteria:o Definitiono Measurabilityo Relevanceo Reliability- Revenue realization principle—revenue should be recognized only after the earnings process is complete or virtually complete and should be recognized as earned in period earned—critical event: usually DELIVERY (point of sale)- Matching principle has four approached:1. Based on exact cause and effect relationships (COGS)2. Associating expenses with the revenues recognized in a specific time period (monthly salary payments to employees)3. A systematic and rational allocation to specific time periods (straight line depreciation)4. In the period incurred, without regards to revenues (admin expenses, advertising expenses)Chapter 2—review of the accounting process- Internal transactions do not involve an exchange transaction but do affect thefinancial position of the company—adjusting entries—nothing else is happening, just recognizing different things- Acquire assets either by borrowing or provided by own cash- When assets go up, either have to increase liabilities or increase S/E- Net income either gets disbursed as dividends or kept as retained earnings- Dividends are NOT an expense but debit/credit wise get treats like one (when you pay out dividends, debit dividends and credit cash)- Steps of the accounting process cycle1. Obtain information about external transactions form source documents (always need paper trail)2. Analyze transactions3. Record the transactions in a journal4. Post from the journal to the general ledger (t-accounts)5. Prepare an unadjusted trial balance—tests if debits=credits6. Record adjusting entries and post to the general ledger accounts7. Prepare an adjusted trial balance—tests if debits=credits8. Prepare financial statements (I/SREB/SSCF)9. Close the temporary accounts to retained earnings (rev, income summary—income summary, expense—income summary, retained earnings—retained earnings, dividends----income summary is a madeup account)10.Prepare a post-closing trial balance- On the post closing trial balance (at year end ONLY), it is only permanent balance sheet accounting because revenues and expenses were closed (zerod) out- When preparing financial statements, there’s no way to get from the income statement to the balance sheet without finding retained earnings—don’t forget to include RE in SE to find total L&SEo Beginning RE + Net Income – Dividends = Ending RE- The statement of shareholders equity presents changes in various PERMANENT shareholders equity accounts that occurred during the period from investments by owners, distributions to owners, net income, and other comprehensive income- Conversion from CASH BASIS to ACCRUAL BASISo Add increases in an asset; Deduct decreases in assets An increase in accounts receivable means that the company earned more revenue than cash collected, requiring the addition to cash basis incomeo Add decreases in accrued liabilities; Deduct increases in accrued liabilities A decrease in interest payable means that the company incurred less interest expense than the cash interest it paid, requiring the addition to cash basis income Cash ‘income’ is just an inflow and outflow of cash—not actual revenues and expenses Make journal entries for the increases/decreases in accounts If a revenue would have been recognized through the accrual method, add that amount to cash basis income (because revenue increases accrual income) If an expense would have been recognized through the accrual method, subtract that from cash basis income (because an expense decreases accrual income) Since a decrease in cash in the accrual method isn’t considered an expense (like the cash basis) you have to add cash decreasesback into accrual income if you decrease your cash  Since an increase in cash increases the cash basis income but wouldn’t be considered revenue in the accrual method, if cash increases, it needs to be subtracted from cash based income****fuck this conceptually—memorize table!****INCREASES DECREASESASSETS add deductLIABILITIES deduct addChapter 3—The Balance Sheet and Financial Disclosures- Balance sheet usefulness and limitationso Reports a company’s financial position on a particular dateo Described many of the resources a company has for generating future cash flowso Provides liquidity information useful in assessing a company’s ability to pay its CURRENT obligations (liabilities)o Provides long term solvency information relating to the riskiness of a company with regard to the amount