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 everything we have done so far comes from this equation It s importance can t be overstated Assets Liabilities Stockholders Equity 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 Assets Earnings 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 5 000 Notes Payable 5 000 2 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 5 000 5 000 Equipment Now for the sake of being complete if we look at the two examples and combine them we will see that Debits Credits Okay before we wrap up this quick review of chapter 3 we need to look at another accounting technique introduced to us the Trial Balance The trial balance lists accounts and their balances at a given time The trial balance proves the mathematical equality of debits and credits
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