C213 Study Guide - Solution

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213

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Accounting

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Jan 9, 2024

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WARNING: Study Guide is not a replacement of the e-text. This is supplement to the text only. C213 Study Guide Solutions Chapter 1: Nature and Purpose of Accounting Describe the purpose of accounting. Accounting is the recording of the day-to-day financial activities of a company and the organization of that information into summary reports used to evaluate the company's financial status. Accounting is formally defined as a system of providing "quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions." Bookkeeping is a part of accounting. Bookkeeping refers to the process of recording transactions into various accounts, which is the first step in accounting. The next step is to analyze the accounts and organize them into financial statements and other useful reports. (Reference topic 1.1) Bookkeeping is the preservation of a systematic, quantitative record of an activity. Bookkeeping systems can be very primitive— making marks in a stick to tally how many sheep you have or moving beads on a string to track the score in a billiards game. Describe the three financial statements. (outside of the company) The balance sheet reports a company's assets, liabilities, and owners' equity. It reports the financial position of a firm at a point in time. Assets = Liabilities + Equity The income statement reports the amount of net income earned by a company during a period. Net income is the excess of a company's revenues over its expenses. It reports the financial performance of a firm over a period of time. Net Income = Revenue - Expenses The statement of cash flows reports the amount of cash collected and paid out by a company in the following three types of activities: operating, investing, and financing over a period of time. (Reference topic 1.2) 1

Inflow of Cash (Receipts) ->CASH -> Outflows of Cash (Payments) Identify users of financial statements for a particular situation. Lenders Banks use companies' financial statements in making decisions about commercial loans. The financial statements are useful because they help the lender predict the future ability of the borrower to repay the loan. Investors Investors want information to help them estimate how much cash they can expect to directly receive from the business in the future if they invest in it now. Company Management Managers use financial accounting data to formulate company goals, to compute bonuses for employees, and to illuminate company weaknesses. Suppliers and Customers Suppliers, customers, and employees use financial statements to tell them about the long-run prospects of a company. Employees Financial statement data, as mentioned earlier, are used in determining employee bonuses. In addition, financial accounting information can help an employee evaluate the employer's ability to fulfill its long-run promises, such as for pensions and retiree health care benefits. Financial statements are also important in contract negotiations between labor and management. Competitors Competitors use financial accounting information to reveal strategic opportunities within their industry. Government Agencies Government agencies use financial statement data to bolster political and regulatory positions for and against companies. Politicians Politicians use financial statement data to bolster political and regulatory positions for and against companies. The Press 2

Reporters use financial accounting data as background information and to indicate which companies are undergoing significant changes in financial status. (Reference Topic 1.3) Differentiate the roles of important accreditation organizations. CPA Accreditation - The American Institute of Certified Public Accountants (AICPA) is the professional organization of certified public accountants (CPAs) in the United States. A CPA is someone who has taken a minimum number of college-level accounting classes, has passed the CPA exam, and has met other requirements set by his or her state. A CPA firm is a company that provides freelance business advice, particularly in connection with accounting issues and executes the vast majority of external audits in the US. The AICPA sets ethical standards for CPAs, provides continuing education for them, writes and grades the CPA exam, lobbies for legislation favored by CPAs, and provides other support to CPAs. Its oversight of the CPA exam is its main role in accreditation. However, to be accredited as a CPA you must meet the requirements of the state in which you plan to practice. The requirements for each state are set by that state’s legislature and overseen by that state’s Board of Accountancy, which is a state agency. (Reference Topic 1.5) Public Company Accounting Oversight Board (PCAOB) – The PCAOB determines who can audit public companies regardless of whether the audit firm is accredited by a state Board of Accountancy. Thus, they accredit firms that can audit public companies. Describe current trends that are causing changes in the field of accounting. Globalization – As more and more business do business globally, capital flows more freely across national boundaries. This means investors can choose to invest in firms all over the planet. To help them make investment decisions, the global accounting and regulatory communities are working to bring accounting standards around the world into agreement the IASB was one step in that direction, but nations still control the accounting standards used within their borders and so much of the standardization is being done through voluntary cooperation Technology – Information technology has speeded up the pace with which accounting data and reports are produced and dramatically increased the volume of accounting information that firms can provide to investors. (Reference Topic 1.6) 3

Chapter 2: Overview of Financial Statements Identify the purposes of financial statements in specific situations. The main different uses of financial statements depends on how different users use them. Here is a list of the major users and how their use of financial statements differs. Lenders Banks use companies' financial statements in making decisions about commercial loans. The financial statements are useful because they help the lender predict the future ability of the borrower to repay the loan. Investors Investors want information to help them estimate how much cash they can expect to directly receive from the business in the future if they invest in it now. Company Management Managers use financial accounting data to formulate company goals, to compute bonuses for employees, and to illuminate company weaknesses. Suppliers and Customers Suppliers, customers, and employees use financial statements to tell them about the long-run prospects of a company. Employees Financial statement data, as mentioned earlier, are used in determining employee bonuses. In addition, financial accounting information can help an employee evaluate the employer's ability to fulfill its long-run promises, such as for pensions and retiree health care benefits. Financial statements are also important in contract negotiations between labor and management. Competitors Competitors use financial accounting information to reveal strategic opportunities within their industry. Government Agencies Government agencies use financial statement data to bolster political and regulatory positions for and against companies. Politicians Politicians use financial statement data to bolster political and regulatory positions for and against companies. 4

The Press Reporters use financial accounting data as background information and to indicate which companies are undergoing significant changes in financial status. (Reference Topic 1.3) Identify components of a balance sheet. The three main sections of the Balance Sheet are Assets, Liabilities, and Equity. Both assets and liabilities are further separated into current and long term based on whether the asset is expected to be consumed or the liability paid within a year. Assets expected to be consumed and liabilities expected to be paid within a year are current and those that will be consumed or paid after a year are long-term. Equity is separated into paid in capital (also referred to as capital stock) and retained earnings. Paid in capital is created when an owner buys stock from the firm. Retained earnings are the accumulated earnings of the firm (i.e., net income over time) that have not been paid back in dividends. Paid in capital also is referred to as contributed capital while retained earnings is earned capital. Use the accounting equation to calculate total assets, total liabilities, or total stockholders’ equity. The Balance Sheet equation: Assets = Liabilities + Equity. Given values for any two of the three components you can always calculate to third component using this equation. For example, if you know a firm’s total assets and liabilities, you can calculate owners’ equity by: Assets – Liabilities = Equity Identify components of the income statement. The Income Statement describes a company’s financial performance for a period of time. A company's expenses are subtracted from its revenues and gains and losses are also factored in computing net income. Net income helps explain the change in retained earnings between two Balance Sheet dates, along with dividends and unrealized gains and losses. A single step income statement lumps all revenues together and subtracts all expenses to calculate net income. A multiple-step presents subtotals that highlight key performance measures. Its categories include: Sales or revenues - Cost of goods sold (COGS) (Product costs of items sold) = Gross profit - Selling and Administrative expenses (also called operating expenses) = Operating income or earnings before interest and taxes (EBIT) 5

+ Other income - other expenses + gains - losses = Earnings before taxes (EBT) - Taxes = Net Income (Profit) If the firm has experienced a discontinued operation or extraordinary item, the effects of these events are subtracted from all the income statement line items and the income statement will include another subtotal – income from continuing operations that will be followed by a single line item that presents to effects of the extraordinary item discontinued operations and then net income. Identify components of the cash flow statement. The Statement of Cash Flows details how a company obtained and spent cash during a certain period of time. Thus, the cash flow statement explains the change in the firm’s cash account for a period of time. All of a company's cash transactions are categorized as either operating, investing, or financing activities. i) Operating cash flows are those associate with any activity on the income statement. The operating section of the cash flow statement is what the income statement would show if the income statement were prepared on a cash basis and not accrual basis. - (Receipts) : Treat as positive amounts  Collections from customers  Interest received  Dividends received - (Payments): Treat as negative amounts  Payments to suppliers (inventory purchases)  Wages and salaries paid  Interest paid  Taxes paid  Rent paid  Utilities paid  Purchase of Insurance ii) Investing cash flow are those related to a firm investing in itself (purchasing and selling property, plant and equipment or other businesses) and investing in others (buying the stocks and bonds of another firm or lending another firm money). - Receipts: Treat as Positive Amounts  Sale of property, plant, and equipment  Sale of securities of another company  Collections of loans made to third parties (principle only) - Payments: Treat as negative Amounts 6

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