Untitled 3

ch 1

accounting equation (ch 1):

the balance sheet shows the relationship between assets, liabilities, & stockholder’s equity at a particular date. in equation form, assets = liabilities + stockholder’s equity. this is referred to as the basic accounting equation.

financial statements (ch 1) format/content (which accounts belong on each financial statement):

4 types of financial statements:

income statement:

summarizes all revenue & expenses for period (month, quarter, or year). if revenues exceed expenses, the result is a net income. if expenses exceed revenue, the result is a net loss.


service revenue


salaries & wages expense

supplies expense

rent expense

insurance expense

interest expense

depreciation expense

total expenses

net income

retained earnings statement:

indicates amount paid out in dividends & amount of net income or net loss for period. shows changes in retained earnings balance during period covered by statement. time period is the same as that covered by income statement.

retained earnings, october 1

add: net income

less: dividends

retained earnings, october 31

balance sheet:

shows the relationship between assets, liabilities, & stockholders’ equity at a particular date.



accounts receivable


prepaid insurance


total assets

liabilities & stockholder’s equity


notes payable

accounts payable

salaries & wages payable

unearned service revenue

interest payable

total liabilities

stockholders’ equity

common stock

retained earnings

total stockholders’ equity

total liabilities & stockholders’ equity

statement of cash flows:

reports cash inflows & outflows resulting from financing, investing, & operating activities during the period. reports the cash effects of a company’s operations for a period of time. shows cash increases & decreases from investing & financing activities. indicates increase or decrease in cash balance as well as ending cash balance.

cash flows from operating activities

cash receipts from operating activities

cash payment for operating activities

net cash provided by operating activities

cash flows from investing activities

purchased equipment

net cash used by investing activities

cash flows from financing activities

issuance of common stock

issuance of note payable

payment of dividend

net cash provided by financing activities

net increase in cash
cash at the beginning of period
cash at the end of period

transaction classification on statement of cash flows (operating, investing, financing activities) (ch 1):

operating activities:

comprise the primary activities for which the organization is in business. include cash activities related to net income. for example, cash generated from the sale of goods (revenue) & cash paid for merchandise (expense) R operating activities because revenues & expenses R included in net income.

investing activities:

investing activities involve the purchase of resources (assets) needed to operate the business. typical assets include:

land, building, equipment, cash, investments in debt or equity securities of another company
financing activities:

to start or expand a business the owner or owners quite often need cash from outside sources. the 2 primary sources R:

borrowing from creditors

liabilities R amounts owed to creditors

note payable (bank loan)

bonds payable (debt securities)

selling shares of stock to investors

common stock (total amount paid in by stockholders for the shares they purchased)

dividends (payments to stockholders)

net income calculation (ch1):

net income results when revenues exceed expenses. to find net income, subtract total expenses from total revenues. if expenses exceed revenues, U have a net loss.

ch 2

profit margin calculation (ch2):

a profit margin is a figure representing the profitability of a company, expressed as a percentage on the company’s income statement. the stronger the percentage, the more m1y the company is earning, after all expenses R paid. gross profit margin = (net sales – cost of goods sold) / net sales.
current ratio – calculation & interpretation (ch2):

the current ratio is used to measure a company’s short-term liquidity position & provides a quantitative relationship between current assets (ca) & current liabilities (cl). the current ratio = current assets/current liabilities


if current assets > current liabilities, then ratio is greater than 1.0 -> a desirable situation to be in.

if current assets = current liabilities, then ratio is equal to 1.0 -> current assets R jst enough to paydown the short term obligations.

if current assets < current=”” liabilities,=”” then=”” ratio=”” is=”” less=”” than=”” 1.0=”” -=””> a problem situation at hands as the company does not have enough to pay for its short term obligations.
classified balance sheet (current/ppe/intangibles, current/long-term liabilities) (ch 2)
retained earnings statement (ch 2)

ch 4

revenue recognition principle & expense recognition principle (ch4)

revenue recognition principle:

companies recognize revenue in the accounting period in which the performance obligation is satisfied.

expense recognition principle:

companies recognize expense in the period which efforts R made to generate revenue.
adjustments (ch 4): prepaid expenses (all types)/unearned revenue/accruals (revenue & expense)

2 types of adjustment:


prepaid expenses:






accumulated depreciation-equipment is a contra asset account.


equipment & buildings R recorded as assets, rather than an expense, in the year acquired.

expenses paid in cash before they R used or consumed. costs that expire either with the passage of time or through use. an adjustment results in an increase to an expense account & a decrease to an asset account or increase to a contra-asset.

unearned revenues:


magazine subscriptions

airline tickets

customer deposits

cash received before services R performed & recorded as a liability. adjustment is made to record the revenue for services performed during the period & to show the liability that remains. adjustment results in a decrease to a liability account & an increase to a revenue account.


accrued revenues:



services performed

revenues for services performed but not yet received in cash or recorded. shows the receivable that exists, & records the revenues for services performed. this adjustment: increases an asset account & a revenue account.

accrued expenses:





expenses incurred but not yet paid in cash or recorded. an adjustment records the obligations & recognizes the expenses. this type of adjustment increases an expense account & a liability account.
accrual accounting definition (ch 4):

transactions recorded in the periods in which the events occur. revenues R recognized when services performed, even if cash was not received. expenses R recognized when incurred, even if cash was not paid.

ch 5

internal control activities (ch 5):

in internal control, methods & measures R adopted to:

safeguard assets.

the use of a bank contributes significantly to good internal control over cash.

minimizes the amount of currency on hand.

creates a double record of bank transactions.

enhance accuracy & reliability of accounting records.

increase efficiency of operations.

ensure compliance with laws & regulations.

internal control activities:

establishment of responsibility

control is most effective when only 1 person is responsible for a given task.

establishing responsibility often requires limiting access only to authorized personnel, & then identifying those personnel.

segregation of duties

different individuals should be responsible for related activities.

the responsibility for record-keeping for an asset should be separate from the physical custody of that asset.

documentation procedures

companies should use prenumbered documents, & all documents should be accounted for.

employees should promptly forward source documents for accounting entries to the accounting department.

physical controls

vaults, alarms, time clocks, biometric security.

independent internal verification

records periodically verified by an employee who is independent.

discrepancies reported to management.

human resource controls

bond employees who handle cash.

rotate employees’ duties & require vacations.

conduct background checks.

bank reconciliation preparation & related adjustments (ch 5):

in a bank reconciliation, cash balances must be balanced according to both the bank & the company.

for bank:

adjustments include those for deposits in transit, outstanding checks, & bank errors.

deposits in transit:

deposits recorded by the depositor (company) that have not been added to the bank’s records. (time lag)

R an increase(+)

outstanding checks

checks issued & recorded by the company that have not been subtracted from the bank’s records. (time lag)

R a decrease(-)

bank errors

can increase or decrease(+/-)

for company:


a check written by a customer that is not paid by the bank because of insufficient funds in the customer’s bank account. “bounced check”

R a decrease(-)

eft or interest earned

funds transferred electronically between locations. can be receipts or payments.

R an increase(-)

bank service fees/fees

R a decrease(-)

book errors

R an increase or decrease(+/-)

adjustments include those for eft collections & other deposits, nsf (bounced) checks, service charges & other payments, & company errors.

ch 6

step income statement (gross profit, operating income, other rev/exp) (ch 6) step income statement:

highlights the comp1nts of net income & includes 3 important line items, including gross profit, income from operations & net income.
gross profit calculation & ratio (ch 6):

gross profit:

gross profit is the profit a company makes after deducting the costs associated with making & selling its products, or the costs associated with providing its services. it can be calculated by subtracting the cost of goods sold from revenue, or revenue – cost of goods sold = gross profit.

gross profit ratio:

the gross profit ratio is a profitability ratio that shows the relationship between gross profit & total net sales revenue. it can be calculated by dividing gross profit by net sales multiplied by 100, or gross profit / net sales * 100 = gross profit ratio
bad debt expense – calculation & adjustments (ch 6):

bad debt expense can be calculated by multiplying the estimated percentage of sales that will remain uncollected by the amount of sales. or estimated % sales uncollectable * sales.

estimated % sales uncollectible can be calculated by dividing the amount of bad debt by the total accounts recievable for a period, & multiply by 100. or bad debt / total accounts receivable for period * 100.


under the allowance method for uncollectible accounts:

companies estimate uncollectible accounts receivable.

increase bad debt expense & increase allowance for doubtful accounts(a contra account).

companies decrease allowance for doubtful accounts & decrease accounts receivable at the time the specific account is written off as uncollectible.

off of bad debts – how impacts accounting equation (ch 6):

a write-off affects only balance sheet accounts. cash realizable value in the balance sheet, therefore, remains the same before & after the write-off.
perpetual inventory – definition & entries (ch 6):

in a perpetual inventory system, there R maintained detailed records of the cost of each inventory purchase & sale. records continuously show inventory that should be on hand for every item. company determines cost of goods sold each time a sale occurs.

in recording purchases in a perpetual inventory system, increase inventory & decrease cash /or increase accounts payable

sales may be made on credit or for cash.

sales revenue, like service revenue, is recorded when the performance obligation is satisfied.

performance obligation is satisfied when the goods R transferred from the seller to the buyer.

there R 2 types of entries to be made:

increase revenue & increase cash /or accounts receivable

decrease inventory & increase cost of good sold (expense)

when items purchased R later returned:

sales returns & allowances is shown as a subtractive item under revenues (contra-revenue)

accounts receivable also reduced.

if goods R returned, inventory is increased & cost of goods sold is decreased for the cost of the goods.

if the goods were defective, inventory is reduced to reflect the decline in value.

lifo/fifo – cogs & ending inventory calculations & entries (ch 6):


costs of the latest goods purchased R the 1st to be recognized in determining cost of goods sold.

a major shortcoming of the lifo method is that in a period of inflation, the costs allocated to ending inventory may be significantly understated in terms of current cost.


costs of the earliest goods purchased R the 1st to be recognized in determining cost of goods sold.

a major advantage of the fifo method is that in a period of inflation, the costs allocated to ending inventory will approximate their current cost.

cost of goods sold:

lifo: with lifo, U use the last 3 units to calculate cost of goods sold expense.

fifo: in short, U use the 1st 3 units to calculate cost of goods sold expense.

ending inventory:

beginning inventory + net purchases – cost of goods sold (or cogs)

ch 7

acquisition cost of assets (what to include & entry) (ch 7):

the cost of acquiring assets:


all necessary costs incurred in making land ready for its intended use increase the land account.

included costs:

cash purchase price

closing costs such as title & attorney’s fees

real estate brokers’ commissions

accrued property taxes & other liens on the land assumed by the purchaser.


includes all costs related directly to purchase or construction.

included costs:

purchase costs

purchase price, closing costs (attorney’s fees, title insurance, etc.) & real estate broker’s commission.

remodeling & replacing or repairing the roof, floors, electrical wiring, & plumbing.

construction costs

contract price plus payments for architects’ fees, building permits, & excavation costs.


include all costs incurred in acquiring the equipment & preparing it for use.

included costs:

cash purchase price.

sales taxes.

fr8 charges.

insurance during transit paid by the purchaser.

expenditures required in assembling, installing, & testing the unit.

depreciation – definition, calculation & entry (straight-line only) (ch 7):


process of allocating to expense the cost of a plant asset over its useful life in a rational & systematic manner.

applies to land improvements, buildings, & equipment, not land.

affected by 3 factors, including salvage value, cost, & useful life


under the straight-line method, the depreciation expense can be calculated by dividing the depreciable cost by the useful life in years. the depreciable cost can be calculated by subtracting salvage value from cost. in terms of a formula:

depreciable cost = salvage value – cost

depreciation expense = depreciable cost / useful life in years
net book value – definition & calculation (ch 7):


the book value is defined as the difference between the cost of any depreciable asset & its related accumulated depreciation.

calculation: cost of depreciable asset – accumulated depreciation for that asset = net book value
sale of assets – calculation of gain/loss & entry (ch 7)

eliminate asset by (1) decreasing accumulated depreciation, & (2) decreasing the asset account.

to start:

compare the book value of the asset with the proceeds received from the sale.

calculation of:

gain: if proceeds exceed the book value, a gain on disposal occurs.

loss: if proceeds R less than the book value, a loss on disposal occurs.

ch 8

current liabilities vs. long-term liabilities on the balance sheet (ch 8)

current liabilities:

a debt that a company expects to pay from existing current assets or through the creation of other current liabilities, & within 1 year or the operating cycle, whichever is longer.

current liabilities include notes payable, accounts payable, unearned revenues, & accrued liabilities such as taxes, salaries & wages, & interest.

interest on notes = face value x annual interest rate x fraction of the year

term liabilities:

a long-term liability is a noncurrent liability. that is, a long-term liability is an obligation that is not due within 1 year of the date of the balance sheet (or not due within the company’s operating cycle if it is longer than 1 year).

examples include:

bonds payable

term loans

deferred revenues

deferred income taxes

treasury stock – definition, journal entry, & how handled on balance sheet (ch 8)


treasury stock is a corporation’s own stock that has been reacquired by the corporation & is being held for future use.

purchase of treasury stock:

generally accounted for by the cost method.

increase treasury stock for the price paid.

treasury stock is a contra stockholders’ equity account, not an asset.

treasury stock decreases by the same amount when the company later sells the shares.

stockholders’ equity section of balance sheet (ch 8)

stockholders’ equity:

balance sheet presentation of stockholders’ equity

2 classifications of paid-in capital:

capital stock

additional paid-in capital

in capital is the total amount of cash & other assets paid in to the corporation by stockholders in exchange for capital stock.

other comprehensive income items include:

certain adjustments to pension plan assets,

types of foreign currency gains & losses, &

some gains & losses on investments.

stock issuance entries (common & preferred stock) (ch 8)

stock issuance for:

common stock:

corporation can issue common stock directly to investors or indirectly through an investment banking firm.

direct issue is typical in closely held companies. indirect issue is customary for a publicly held corporation.

preferred stock:

typically, preferred stockholders have a priority in relation to dividends & assets in the event of liquidation. however, they sometimes do not have voting rights.

stock terms (authorized, issued, outstanding shares) (ch 8)

stock terms for:

authorized shares:

authorized stock is the maximum number of shares that a corporation is legally permitted to issue, as specified in its articles of incorporation. it is also usually listed in the capital accounts section of the balance sheet.

issued shares:

issued stock is a corporate stock which is issued & held in the corporation’s treasury or sold or distributed to shareholders. in other words, the total number of a company’s shares that was sold & held by shareholders. it is to be noted that issued stock can be held both by insiders & by the general public.

outstanding shares:

the number of shares the corporation has actually issued that R held by the public.

dividend dates & related entries (ch 8)

dividend dates:

a dividend is a distribution to stockholders on a pro rata (proportional to ownership) basis.

types of dividends:

cash dividends.

stock dividends.

property dividends.

scrip (promissory note)

dividends R generally reported quarterly as a dollar amount per share.

dividends require information concerning 3 dates:

declaration date:

board authorizes dividends

record date:

registered shareholders R eligible for dividend

payment date:

the company issues dividend checks

retained earnings – calculation of ending balance (chs 1 & 8)

retained earnings:

retained earnings is net income that a corporation retains for future use in the business.

calculation of ending balance:

re = beginning period re + net income/loss – cash dividends – stock dividends

ch 10

manufacturing costs & product versus period costs (ch10)

manufacturing costs:

classified as either direct materials, direct labor, & manufacturing overhead.

indirect materials & labor R also counted as part of manufacturing overhead

manufacturing overhead

indirect materials

indirect labor

depreciation on factory buildings & machines, insurance, taxes, & maintenance on factory facilities.

product costs:

costs that R an integral part of producing the product. recorded in “inventory” account. not an expense (cogs) until the goods R sold.

consist of:

direct materials

direct labor

manufacturing overhead

period costs:

charged to expense as incurred.

manufacturing costs.

includes all selling & administrative expenses.

cost of good manufactured & cost of goods sold calculations (ch10)

cost of goods manufactured:

cost of goods manufactured = beginning work in process inventory + total manufacturing costs(sum of direct material costs, direct labor costs, & manufacturing overhead in the current year) – ending inventory work in progress

cost of goods sold:

for merchandiser:

cost of goods sold = beginning merchandise inventory + cost of goods purchased – ending merchandise inventory

for manufacturer:

cost of goods sold = beginning finished goods inventory + cost of goods manufactured – ending finished goods inventory
manufacturers’ financial statements & how they R difference from a merchandiser (ch10)

under a periodic inventory system:

the income statements of a merchandiser & a manufacturer differ in the cost of goods sold section.

the balance sheet for a merchandiser shows only 1 category of inventory. inventory.

the balance sheet for a manufacturer shows 3 categories of inventory, including raw material inventory, work in process inventory, & finished goods inventory

ch 11

even point calculation (ch11): even point is calculated as such, fixed costs/contribution per unit. even point in dollars is calculated as such, sales price per unit x break-even point in units.
sales to meet target profit calculation & margin of safety calcuation (ch11)

required sales to meet target profit:

required sales may be expressed either in sales dollars or sales units. required sales in dollars can be calculated as such, required sales = variable costs + fixed costs + target net income

required sales in units can be calculated as such, fixed costs + target net income / contribution margin per unit. contribution margin per unit = sales price per unit – variable expenses per unit.

margin of safety:

it is the difference between actual or expected sales & sales at the break-even point. it may be expressed in dollars or as a ratio.

margin of safety in dollars calculation:

actual sales – break-even point

margin of safety as a percentage:

margin of safety in dollars(actual sales – break-even point) / actual sales
use high/low method to determine variable & fixed comp1nts of a mixed cost (ch11):

the high/low method uses the total costs incurred at the high & the low levels of activity to classify mixed costs into fixed & variable comp1nts.

calculation to determine variable & fixed cost comp1nts of mixed cost:

step 1: calculate variable cost per unit using the identified high & low activity levels

variable cost = (total cost of high activity – total cost low activity) / (highest activity unit – lowest activity unit)

step 2: solve for fixed costs

to calculate the total fixed costs, plug either the high or low cost, & the variable cost into the total cost formula.

total cost = (variable cost per unit x units produced) + total fixed cost

step 3: construct total cost equation based on high-low calculations above

total cost = variablecostx + total fixed costs.

identify variable/fixed/mixed costs (ch11)

variable costs:

costs that vary in total directly & proportionately with changes in the activity level.

example: if the activity level increases 10 percent, total variable costs increase 10 percent.

variable costs remain the same per unit at every level of activity.

examples: raw materials, packaging, & labor directly involved in a company’s manufacturing process.

fixed costs:

costs that remain the same in total regardless of changes in the activity level within a relevant range.

fixed cost per unit cost varies inversely with activity:  as volume increases, unit cost declines, & vice versa.

examples: property taxes, insurance, rent, depreciation on buildings & equipment.

mixed costs:

costs that have both a variable element & a fixed element.

change in total but not proportionately with changes in activity level.

preparation of a cvp income statement (ch11)


behavior of both costs & revenues is linear throughout the relevant range of the activity index.costs can be classified accurately as either variable or fixed.changes in activity R the only factors that affect costs. all units produced R sold.when more than 1 type of product is sold, the sales mix will remain constant.

cvp income statement:

a statement for internal use.

classifies costs & expenses as fixed or variable.

reports contribution margin in the body of the statement.

contribution margin–amount of revenue remaining after deducting variable costs.

reports the same net income as a traditional income statement.

ch 13

budgeting (ch13)
production budget/cash budget/comp1nts of operating & master budgets

production budget:

shows units that must be produced to meet anticipated sales.

derived from sales budget plus the desired change in ending finished goods inventory.

formula: required production units = budgeted sales units + desired ending finished goods units – beginning finished goods units.

cash budget:

shows anticipated cash flows.

often considered to be the most important output in preparing financial budgets.

ending cash balance of 1 period is the beginning cash balance for the next.

contains 3 sections:

cash receipts

expected receipts from the principal sources of revenue.

expected interest & dividends receipts, proceeds from planned sales of investments, plant assets, & the company’s capital stock.

cash disbursements

expected cash payments for direct materials, direct labor, manufacturing overhead, & selling & administrative expenses.


expected borrowings & repayments of borrowed funds plus interest.

shows beginning & ending cash balances.

comp1nts of operating budgets:

individual budgets that result in the preparation of the budgeted income statement & establish goals for sales & production personnel.

sales budget, production budget, direct materials purchases budget, direct labor budget, overhead budget, ending finished goods inventory budget, cost of goods sold budget, selling & administrative expenses budget, budgeted income statement

comp1nts of master budgets:

set of interrelated budgets that constitutes a plan of action for a specified time period.

contains 2 classes of budgets:

operating budgets

financial budgets

ch 16

use cash payback method, net present value method, & annual rate of return method to evaluate capital
budget projects (ch16)

cash payback method:

cash payback technique identifies the time period required to recover the cost of the capital investment from the net annual cash inflow produced by the investment.

shorter payback period = more attractive the investment

cash payback period = cost of capital investment / net annual cash flow

net present value method:

discounted cash flow technique.

generally recognized as the best approach.

considers both the estimated total cash inflows & the time value of m1y.

net present value (npv) is the difference between the present value of cash inflows & the present value of cash outflows over a period of time.

npv is used in capital budgeting & investment planning to analyze the profitability of a projected investment or project.

npv = (today’s value of the expected cash flows) – (today’s value of invested cash)

net present value variables:

dollar amount to be received (future amount).

length of time until amount is received (number of periods).

interest rate (the discount rate).

net present value for a single cash flow:

present value = cash flow / (1 + i)^n

i = discount rate & n = period number

annual rate of return method:

indicates the profitability of a capital expenditure by dividing expected annual net income by the average investment.

annual rate of return = expected annual net income / average investment

average investment = original investment + value at end of useful life / 2