Financial Accounting Study Guide Exam 1 Chapter One Introduction to Financial Statements Income Statement always complete the income statement first o Revenue expenses net income loss o UNEARNED REVENUE NOT ON INCOME SHET IT S A LIABILITY Retained Earnings earnings o Beginning retained earnings net income dividends end retained Balance Sheet Accounting Equation For a specific period of time o Assets Liabilities Stockholders equity Assets anything owned Liabilities anything owed Stockholders equity Retained earnings and Common stock net worth o Can also be referred to as a bottom line Statement of Cash flows o Cash from Operations activities Cash inflow from Operating Activities Cash outflow from Operating activities Examples of Operating activities inflows sales commission fees interest and dividends outflow inventories salaries operating expenses interest and taxes Supplies are operating because they are not long term o Cash from Investing activities Cash inflow from Investing Activities Cash outflow from Investing Activities Examples of Investing activities inflow selling long term assets market securities etc outflow purchasing long term assets or marketable securities o Cash from Financing Activities Cash inflow from Financing activities cash outflow from Financing activities Examples of Financing activities inflow cash receipts from issuing stock and borrowing money outflow cash payments repay debt and pay dividends o Net change in cash Net operating activities Net financing activities Net cash Investing activities Accounting Transactions o Transactions economic events that require recording in the financial statement balance sheet Each transaction effects some part of the accounting equation Each transaction has at least two parts for example each transaction has an affect on the assets side as well as the liabilities stockholders equity helps balance the sheet Example Transactions o Ron s Wine shop is started when it receives cash of 5 000 from investors in exchange for common stock Cash was given to company common stock exchange for cash Assets goes up 5 000 cash Common stock increases 5 000 REMEMBER LEFT AND RIGHT SIDE ALWAYS NEED TO EQUAL Cash flow Finance inflow increase 5 000 o Ron s Wine shop borrow 1 000 from Ron s friend Ginger not investing just a loan Note payable liability Cash increases 1 000 and Note payable increases by 1 000 as well in order to balance Cash flow Finance inflow increases by 1 000 o Ron s Wine Shop provides a service to a customer and charges 300 Cash increases 300 for providing the service Retained earning increases by 300 Retained increases because the service produced revenue income statement affects retained earning o Retained earnings earned money o RE 0 beginning 300 net income 0 dividends 300 Cash flow Operating section inflow services are produced and receive cash from customers for everyday business If you pay an expense for example utility bill retained earning goes down because net income goes down Chapter 2 A further look at financial statements Classified Balance Sheet not on exam just need to understand which items are considered an assets liability or stockholders equity GAAP Generally Accepted Accounting Principles o Accrual Accounting Virtually all the major companies operating in the US use accrual accounting Accrual vs Cash Basis Accounting o Accrual Transactions recorded in period which the event occur Example Delta doesn t receive revenue when costumer purchases a 300 ticket receive revenue when the person flies around Delta has a liability to the costumers until the service is done Revenues are recognized when earned rather than when cash Expenses are recognized when incurred rather than when is received paid o Individual use cash basis revenue expenses o Materiality don t have to follow rules if something won t make difference in accounting statement More financial transaction examples o Ron s Wine shop gives seminar on wines of Spain receives 2 000 cash Assets cash increases by 2 000 Net income 2 000 Net income revenue expense 2000 0 2000 Retained earnings 2000 affected by net income Cash flow 2000 operating inflow company receives revenue o Ron s Wine shop purchases inventory 200 bottles of wine at 5 each on account On account Account payable liability Assets increases by 1000 increase in supplies Liabilities increases by 1000 increase in account payable NOT AN EXPENSE YET BECAUSE COMPANY HASN T PAID FOR THE WINE YET EXPENSE IS WHEN IT OCCURS o The wine shop has a broken window repaired for 150 100 cash and 50 on account Assets cash decreases by 100 Liabilities accounts payable increases by 50 Stockholder s equity retained earning decreases by 150 Net of Stockholder s equity and Liabilities 100 same as assets Cash flow 100 operating outflow not 150 because 50 of the expense was put on account o The wine shop sells 150 bottles of the wine for cash 15 each 150 bottles X 15 dollars 2250 revenue 150 X 5 750 750 cost of goods sold Cost of good sold is an expense makes net income one down Assets 2250 750 1500 increase Retained earnings 1500 increase Net income 2250 750 1500 Cash flow 2250 operating increases only based on revenue not affected by the cost of goods sold IF 2250 WAS PAID ON ACCOUNT AND NOT IN CASH THAN REVENUE DOESN T CHANGE CASH DOESN T MATTER If it was on account cash flow would be zero o Ron s wine shop pays a 500 divided to the investors Assets decreases paid 500 in cash Retained earning decreased by 500 Two things make retained go down o Expenses o Dividends not an expense FOR THE BALANCE SHEET THE CHANGE IN ASSETS AND LIABILITIES FOR THE MONTH FEBURARY ARE ADDED SUBTRACTED TO LAST MONTHS JANUARY S ENDING BALANCE Chapter 3 the Accounting Information System Journal where each transaction is recoded o Debit left side When we put something on the left side of an account we are debiting the account Assets have a debit balance o Credit right side crediting the accounting Liabilities have a credit balance o Double entry accounting system When we put something on the right side of an account we are Each transaction must affect two or more accounts to keep the accounting equation in balance Recording done by debiting at least one account and crediting another BALANCE DEBITS MUST ALWAYS EQUAL CREDITS ON TRIAL Each account either has a debit or credit balance Balance goes on the side which has remaining number o Which has the highest amount Revenue and Expense Accounts o Revenue and expense account are not equity
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