Principles of Accounting, Volume 1: Financial Accounting

Chapter 1

Role of Accounting in Society

Summary

Financial accounting measures performance using financial reports and communicates results to those outside of the organization who may have an interest in the company’s performance, such as investors and creditors Managerial accounting uses both financial and nonfinancial information to aid in decision-making The primary goal of accounting is to provide accurate, timely information to decision makers Financial accounting measures an organization’s performance in monetary terms

Key terms

accounting: process of organizing, analyzing, and communicating financial information that is used for decision-making
managerial accounting: process that allows decision makers to set and evaluate business goals by determining what information they need to make a particular decision and how to analyze and communicate…
financial accounting: measures the financial performance of an organization using standard conventions to prepare financial reports
creditor: business that grants extended, but short-term, payment terms to other businesses
Governmental Accounting Standards Board (GASB): source of generally accepted accounting principles (GAAP) used by state and local governments in the United States; is a private nongovernmental organization
not-for-profit (NFP) accounting: including charities, universities, and foundations, helps ensure that donor funds are used for the intended mission of the not-for-profit entity
privately held company: company whose stock is available only to employees or select individuals or groups

Chapter 2

Introduction to Financial Statements

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Summary

The income statement lists revenues, expenses, gains, and losses, which make up net income (or net loss) In addition to showing net income or net loss, the statement of owner’s equity shows the investments by and distributions to owners The balance sheet lists assets, liabilities, and owners’ equity Financial statements provide financial information to stakeholders to help them in making decisions

Key terms

gain: increase in organizational value from activities that are “incidental or peripheral” to the primary purpose of the business
loss: decrease in organizational value from activities that are “incidental or peripheral” to the primary purpose of the business
balance sheet: financial statement that lists what the organization owns (assets), owes (liabilities), and is worth on a specific date
net income: when revenues and gains are greater than expenses and losses
net loss: when expenses and losses are greater than revenues and gains
asset: tangible or intangible resource owned or controlled by a company, individual, or other entity with the intent that it will provide economic value
revenue: inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other…
stakeholder: someone affected by decisions made by a company; may include an investor, creditor, employee, manager, regulator, customer, supplier, and layperson

Chapter 3

Analyzing and Recording Transactions

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Summary

The Financial Accounting Standards Board (FASB) is an independent, nonprofit organization that sets the standards for financial accounting and reporting standards for both public- and private-sector businesses in the… The expense recognition principle requires that expenses incurred match with revenues earned in the same period. The Securities and Exchange Commission (SEC) is an independent federal agency that is charged with protecting the interests of investors, regulating stock markets, and ensuring companies adhere to GAAP requirements The FASB uses a conceptual framework, which is a set of concepts that guide financial reporting

Key terms

transaction: business activity or event that has an effect on financial information presented on financial statements
revenue recognition principle: principle stating that a company must recognize revenue in the period in which it is earned; it is not considered earned until a product or service has been provided
Securities and Exchange Commission (SEC): an independent federal agency that is charged with protecting the interests of investors, regulating stock markets, and ensuring companies adhere to GAAP requirements
Financial Accounting Standards Board (FASB): an independent, nonprofit organization that sets the standards for financial accounting and reporting standards for both public- and private-sector businesses in the…
expense recognition principle: (also, matching principle) matches expenses with associated revenues in the period in which the revenues were generated
account: record showing increases and decreases to assets, liabilities, and equity found in the accounting equation
conceptual framework: interrelated objectives and fundamentals of accounting principles for financial reporting
period: one operating cycle of a business, which could be a month, quarter, or year

Chapter 4

The Adjustment Process

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Summary

The next three steps in the accounting cycle are adjusting entries (journalizing and posting), preparing an adjusted trial balance, and preparing the financial statements. Accrual basis accounting is used by US GAAP or IFRS-governed companies, and it requires revenues and expenses to be recorded in the accounting period in which they occur, not necessarily where an associated cash event… Accounting periods help companies do this by breaking down information into months, quarters, half-years, and full years A calendar year considers financial information for a company for the time period of January 1 to December 31 on a specific year.

Key terms

accounting period: breaks down company financial information into specific time spans and can cover a month, quarter, half-year, or full year
fiscal year: twelve-month reporting cycle that can begin in any month, and records financial data for that twelve-month consecutive period
adjusting entries: update accounting records at the end of a period for any transactions that have not yet been recorded
adjusted trial balance: list of all accounts in the general ledger, including adjusting entries, which have nonzero balances
accrual: type of adjusting entry that accumulates during a period, where an amount was previously unrecorded
calendar year: reports financial data from January 1 to December 31 of a specific year
book value: difference between the asset’s value (cost) and accumulated depreciation; also, value at which assets or liabilities are recorded in a company’s financial statements
useful life: time period over which an asset cost is allocated

Chapter 5

Completing the Accounting Cycle

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Summary

Temporary accounts: Temporary accounts are closed at the end of each accounting period and include income statement, dividends, and income summary accounts Income Summary: The Income Summary account is an intermediary between revenues and expenses, and the Retained Earnings account. Recording closing entries: There are four closing entries; closing revenues to income summary, closing expenses to income summary, closing income summary to retained earnings, and close dividends to retained earnings Closing entries: Closing entries prepare a company for the next period and zero out balance in temporary accounts

Key terms

income summary: intermediary between revenues and expenses, and the Retained Earnings account, storing all the closing information for revenues and expenses, resulting in a “summary” of income…
Income Summary account: an intermediary between revenues and expenses, and the Retained Earnings account
closing: returning the account to a zero balance
classified balance sheet: presents information on your balance sheet in a more informative structure, where asset and liability categories are divided into smaller, more detailed sections
property, plant, and equipment: tangible assets (those that have a physical presence) held for more than one operating cycle or one year, whichever is longer
temporary (nominal) account: account that is closed at the end of each accounting period, and includes income statement, dividends, and income summary accounts
long-term investment: stocks, bonds, or other types of investments held for more than one operating cycle or one year, whichever is longer
post-closing trial balance: trial balance that is prepared after all the closing entries have been recorded

Chapter 6

Merchandising Transactions

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Summary

Their operating cycle begins with cash-on-hand, providing service to customers, and collecting customer payments Their operating cycle begins with cash-on-hand, purchasing inventory, selling merchandise, and collecting customer payments A purchase discount is an incentive for a retailer to pay their account early. Service companies sell intangible services and do not have inventory.

Key terms

operating cycle: amount of time it takes a company to use its cash to provide a product or service and collect payment from the customer
purchase discount: an incentive for a retailer to pay their account early
physical inventory count: manual stock check of inventory to make sure what is recorded on the books matches what is actually in the warehouse and on the sales floor
sales discounts: reduction in the selling price offered to customers who pay their account within the discount period; the actual account is a contra revenue account that reduces sales
goods in transit: time in which the merchandise is being transported from the seller to the buyer
freight-in: buyer is responsible for when receiving shipment from a seller
net income: when revenues and gains are greater than expenses and losses
freight-out: seller is responsible for when shipping to a buyer

Chapter 7

Accounting Information Systems

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Summary

An accounting information system is a set of business processes that record transactions using journals and ledgers (a paper-based system) or computer files (using a computerized system) to keep track of a company’s… The key steps in an accounting information system are input, processing, and output. Processing: This is a method of combining similar kinds of information (like adding all cash sales together to get a total that is separate from all credit sales; and then adding everything to find total sales) Source document: This is a record that a transaction has taken place; it is often used at the input stage

Key terms

accounting information system: a set of business processes that record transactions using journals and ledgers (a paper-based system) or computer files (using a computerized system) to keep track of a
source document: paper document or electronic record that provides evidence that a transaction has occurred and includes details about the transaction
data: parts of accounting transactions that constitute the input to an accounting information system
artificial intelligence: computerized systems that are taught to use reasoning and other aspects of human intelligence to mimic some of the tasks humans perform
big data: data sets from online transactions and other sources that are so large that new software and methods have been created to analyze and mine them so they can provide insight into…
blockchain: underlying technology Bitcoin is built on; provides a single shared ledger used by all of the parties to a transaction resulting in cheaper, more secure, and more private…
cash disbursements journal: special journal that is used to record outflows of cash; every time cash leaves the business, usually when we issue a check, we record in this journal

Chapter 8

Fraud, Internal Controls, and Cash

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Summary

Due to the nature of their functions, internal and external auditors, through the implementation of effective internal controls, are in excellent positions to prevent opportunity-based fraud The fraud triangle helps explain the mechanics of fraud by examining the common contributing factors of perceived opportunity, incentive, and rationalization A petty cash account is an imprest account, so it is only debited when the fund is initially established or increased in amount. A system of internal control is the policies combined with procedures created by management to protect the integrity of assets and ensure efficiency of operations

Key terms

fraud: act of intentionally deceiving a person or organization or misrepresenting a relationship in order to secure some type of benefit, either financial or nonfinancial
internal controls: systems used by an organization to manage risk and diminish the occurrence of fraud, consisting of the control environment, the accounting system, and control activities
fraud triangle: concept explaining the reasoning behind a person’s decision to commit fraud; the three elements are perceived opportunity, rationalization, and incentive
petty cash account: an imprest account, so it is only debited when the fund is initially established or increased in amount
imprest account: account that is only debited when the account is established or the total ending balance is increased
external auditor: generally works for an outside CPA firm or his or her own private practice and conducts audits and other assignments, such as reviews
system of internal control: the policies combined with procedures created by management to protect the integrity of assets and ensure efficiency of operations
internal control system: sum of all internal controls and policies within an organization that protect assets and data

Chapter 9

Accounting for Receivables

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Summary

Accounts receivable must satisfy the following criteria: the customer owes money and has yet to pay, the amount is due in less than a company’s operating cycle, and the account usually does not incur interest When a customer pays for a product or service on a line of credit, the Accounts Receivable account is used. When a customer purchases a product or service on credit, using an in-house account, Accounts Receivable increases and Sales Revenue increases. When the customer pays the amount due, Accounts Receivable decreases and Cash increases

Key terms

receivable: outstanding amount owed from a customer
matching principle: (also, expense recognition principle) records expenses related to revenue generation in the period in which they are incurred
revenue recognition principle: principle stating that company must recognize revenue in the period in which it is earned; it is not considered earned until a product or service has been provided
interest: monetary incentive to the lender, which justifies loan risk; interest is paid to the lender by the borrower
amount: due in less than a company’s operating cycle, and the account usually does not incur interest
accounts receivable: outstanding customer debt on a credit sale, typically receivable within a short time period
allowance for doubtful accounts: contra asset account that is specifically contrary to accounts receivable; it is used to estimate bad debt when the specific customer is unknown

Chapter 10

Inventory

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Summary

The total cost of goods available for sale is a combination of the beginning inventory plus new inventory purchases. These costs relating to goods available for sale are included in the ending inventory, reported on the balance sheet, or become part of the cost of goods sold reported on the income statement Merchandise inventory is maintained using either the periodic or the perpetual updating system. There are four basic inventory cost flow allocation methods, which are alternative ways to estimate the cost of the units that are sold and the value of the ending inventory.

Key terms

periodic inventory system: system that is updated at the end of the period, to match the physical count of goods on hand
goods available for sale: total of all inventory (beginning inventory plus purchased inventory); will either be sold this period or held in period-end inventory
purchases: new acquisitions of merchandise inventory during the period
merchandise inventory: goods held for sale at a given point in the period
conservatism: concept that if there is uncertainty in a potential financial estimate, a company should err on the side of caution and report the most conservative amount
consignment: arrangement whereby goods are available to sell by one party, but owned by another party, without transfer of ownership

Chapter 11

Long-Term Assets

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Summary

Examples of intangible assets are patents, trademarks, copyrights, and goodwill Intangible assets lack physical substance but often have value and legal rights and protections, and therefore are still assets to the firm Costs incurred to purchase an asset that will be used in the day-to-day operations of the business will be capitalized and then depreciated over the useful life of that asset Costs incurred to purchase an asset that will not be used in the day-to-day operations, but was purchased for investment purposes, will be considered an investment asset

Key terms

long-term asset: asset used ongoing in the normal course of business for more than one year that is not intended to be resold
investment: short-term and long-term asset that is not used in the day-to-day operations of the business
useful life: time period over which an asset cost is allocated
goodwill: value of certain favorable factors that a business possesses that allows it to generate a greater rate of return or profit; includes price paid for an acquired company above the…
intangible asset: asset with financial value but no physical presence; examples include copyrights, patents, goodwill, and trademarks
patent: contract providing exclusive rights to produce and sell a unique product without competition for twenty years
trademark: exclusive right to a name, term, or symbol a company uses to identify itself or its products
copyright: exclusive rights to reproduce and sell an artistic, literary, or musical asset

Chapter 12

Current Liabilities

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Summary

Common examples of current liabilities include accounts payable, unearned revenue, the current portion of a noncurrent note payable, and taxes payable Notes payable is a debt to a lender with specific repayment terms, which can include principal and interest. Interest accrued can be computed with the annual interest rate, principal loan amount, and portion of the year accrued Accounts payable typically does not include interest payments

Key terms

note payable: legal document between a borrower and a lender specifying terms of a financial arrangement; in most situations, the debt is long-term
unearned revenue: advance payment for a product or service that has yet to be provided by the company; the transaction is a liability until the product or service is provided
interest: monetary incentive to the lender, which justifies loan risk; interest is paid to the lender by the borrower
principal: initial borrowed amount of a loan, not including interest; also, face value or maturity value of a bond (the amount to be paid at maturity)
taxes payable: liability created when a company collects taxes on behalf of employees and customers
likelihood of occurrence: contingent liability must be recognized and disclosed if there is a probable liability determination before the preparation of financial statements has occurred
current liability: debt or obligation due within one year or, in rare cases, a company’s standard operating cycle, whichever is greater
contingency: current situation, where the outcome is unknown or uncertain and will not be resolved until a future point in time

Chapter 13

Long-Term Liabilities

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Summary

A bond indenture is a legal document containing the principal amount, maturity date, stated interest rate and other requirements of the bond issuer Bond selling prices are determined by the market interest rate at the time of the sale and the stated interest rate of the bond Notes payable and bonds payable are specific types of debt that businesses issue in order to generate financial capital Bonds can be issued under different structures and include different features

Key terms

bond: type of financial instrument that a company issues directly to investors, bypassing banks or other lending institutions, with a promise to pay the investor a specified rate of…
principal: face value or maturity value of a bond (the amount to be paid at maturity); also, initial borrowed amount of a loan, not including interest
stated interest rate: (also, contract interest rate) interest rate printed on the face of the bond that the issuer agrees to pay the bondholder throughout the term of the bond; also known as the…
market interest rate: (also, effective interest rate) rate determined by supply and demand and by the credit worthiness of the borrower
bond indenture: contract that lists the features of the bond, such as the principal, the maturity date, and the interest rate
maturity date: date a bond or note becomes due and payable
book value: difference between the asset’s value (cost) and accumulated depreciation; also, value at which assets or liabilities are recorded in a company’s financial statements
discount on bonds payable: contra liability account associated with a bond that has a stated rate that is lower than the market rate and is sold at a discount

Chapter 14

Corporation Accounting

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Summary

The disadvantages of operating as a corporation include the costs of organization, regulation, and potential double taxation There are key differences between public corporations that experience an IPO and private corporations A corporation’s shares continue to be bought and sold by the public in the secondary market after an IPO The process of forming a corporation involves several steps, which result in a legal entity that can issue stock, enter into contracts, buy and sell assets, and borrow funds

Key terms

corporation: legal business structure involving one or more individuals (owners) who are legally distinct (separate) from the business
double taxation: occurs when income is taxed to the corporation that earned the income, and then taxed again to stockholders when they receive a distribution of the corporation’s income as…
private corporation: corporation usually owned by a relatively small number of investors; shares are not traded publicly, and the ownership of the stock is restricted to only those allowed by the…
secondary market: organized market where previously issued stocks and bonds can be traded after they are issued
capital: cash and other assets owned by a company
authorized shares: maximum number of shares that a corporation can issue to investors; approved by state in which company is incorporated and specified in the corporate charter
ex dividend: status of stock sold between the record date and payment date during which the investor is not entitled to receive dividends
par value: value assigned to stock in the company’s charter and is typically set at a very small arbitrary amount; serves as legal capital

Chapter 15

Partnership Accounting

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Summary

Mutual agency and unlimited liability should be weighed against the tax benefits of partnership The most significant advantage of partnerships is the exemption from tax at the business level. Partners must consider several factors when developing their partnership agreement, such as the contributions and authority of each partner and a means to resolve disputes There are many advantages and disadvantages of partnership as a form of business entity and they should be carefully considered

Key terms

partnership: legal business structure consisting of an association of two or more people who contribute money, property, or services to operate as co-owners of a business
partner: individuals, corporations, and even other partnerships participating in a partnership entity
limited liability: form of legal liability in which a partner’s obligation to creditors is limited to his or her capital contributions to the firm
partnership agreement: document that details the partners’ role, the way profits and loss are shared, and the contributions each partner makes to the partnership
unlimited liability: form of legal liability in which general partners are liable for all business debts if the business cannot meet its liabilities
mutual agency: ability of each partner to act as an agent of the partnership in dealing with persons outside the partnership
most significant advantage of partnerships: the exemption from tax at the business level
general partnership: partnership in which each partner is personally liable to the partnership’s creditors if the partnership has insufficient assets to pay its creditors

Chapter 16

Statement of Cash Flows

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Summary

Preparing the operating section of statement of cash flows by the indirect method starts with net income from the income statement and adjusts for items that affect cash flows differently than they affect net income There are two approaches utilized to prepare the statement of cash flow: the indirect method and the direct method The statement of cash flows presents the sources and uses of cash The statement of cash flows is used to predict future cash flows and to assess the quality of an entity’s earnings

Key terms

statement of cash flows: financial statement listing the cash inflows and cash outflows for the business for a period of time
cash flow: cash receipts and cash disbursements as a result of business activity
direct method: approach used to determine net cash flows from operating activities, whereby accrual basis revenue and expenses are converted to cash basis collections and payments
indirect method: approach used to determine net cash flows from operating activities, starting with net income and adjusting for items that impact new income but do not require outlay of cash
noncash expense: expense that reduces net income but is not associated with a cash flow; most common example is depreciation expense
investing activity: cash business transaction reported on the statement of cash flows from the acquisition or disposal of a long-term asset
net cash flow: method used to determine profitability by measuring the difference between an entity’s cash inflows and cash outflows
operating activity: cash business transaction reported on the statement of cash flows that relates to ongoing day-to-day operations