Financial Accounting – Study Guide

The Purpose and Use of Financial Statements

Income Statement

 Shows revenues and expenses of a company during a period of time.

 Revenue: amounts earned from the sale of goods or services.
 Expense: amounts incurred in the production of revenue.

Statement of Financial Position

 Shows the assets, liabilities, and equity of a company at a specific point in time.
 Asset: resource that a company has at its disposal and can utilize in conducting business.
 Liability: debt that a company has incurred as a result of conducting business.
 Assets = Liabilities + Equity.

Classifications of Assets

 Current assets are used up within 1 year.

 Listed in the order that they can be converted into cash (liquidity order).
 Ex: held for trading investments, accounts receivable, notes receivable.
 Accounts receivable: money owed to a company by customers who purchased on credit.
 Notes receivable: money owed to a company supported by a written promise to pay.
 Non-current assets have a life longer than 1 year.
 Listed longest to shortest life.
 Ex: property, intangible assets, goodwill.

Classifications of Liabilities

 Current liabilities are paid within 1 year.

 Listed in the order they need to be paid (maturity date).
 Ex: unearned revenue, accounts payable, notes payable.
 Accounts payable: money a company owes to suppliers for purchases made on credit.
 Notes payable: money a company owes to suppliers supported by a written promise to pay.
 Long-term liabilities are paid after 1 year.
 Ex: lease obligations, pension obligations, deferred income tax.

Accrual Accounting Concepts

Revenue and Expense Recognition

 Revenue is recognized when services are performed or goods are delivered.

 Expenses are recognized when a decrease in economic benefit occurs (due to ordinary activity).

Cash vs. Accrual Basis of Accounting

  Cash basis of accounting records revenue and expenses only when cash is paid or received.
 Accrual basis of accounting record revenue when it is earned and expenses when incurred.

Adjusting Entries

 Adjusting entries: entries made to adjust accounts at the end of the accounting period.
 Divided into 4 types:
1. Prepaid expenses: expenses paid in cash before they are consumed.
2. Unearned revenue: cash received and recorded as a liability before revenue is earned.
3. Accrued expenses: expenses that have been incurred but not yet paid.
 Interest Expense = Principal Amount x Annual Interest Rate x Time (In Terms of Years).
4. Accrued revenue: revenue that has been earned but not yet recorded.

Depreciation and Amortization

 Depreciation: process of allocating the cost of a tangible asset to expense over its useful life.
 Amortization: process of allocating the cost of an intangible asset to expense over its useful life.
 Cannot reduce the value of an asset directly. Must use contra asset account.
 Why? Need to know original cost. Need to know depreciation amount.

Closing Entries

 Closing entries: temporary account balances are transferred to Retained Earnings.

1. Transfer balances in revenue and expense accounts to Income Summary.
2. Transfer balance in Income Summary to Retained Earnings.
3. Close Dividends into Retained Earnings.