# Financial Accounting

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Financial Accounting

## 1. Ratios

### 1.1. Current ratio

1.1.1. Total current assets / Total current liabilities

1.1.2. Measures ability to pay its current liabilities

1.1.3. In general, >1.5 is safe

1.1.3.1. 1.0 is considered risky

### 1.2. Debt ratio

1.2.1. Total liabilities / Total assets

1.2.2. Measures overall ability to pay debts

1.2.3. In general, <0.6 is safe

1.2.3.1. >0.8 is considered risky

### 1.3. Gross Profit Percentage (Gross margin percentage)

1.3.1. Gross profit / Net sales revenue

1.3.1.1. Net sales revenue = Sales revenue - Sales returns and allowances - Sales discounts

1.3.1.2. Gross profit = Net sales revenue - Cost of goods sold

1.3.2. Measures profitabilitiy

1.3.3. Small increase may signal an important rise in income, and vice versa

### 1.4. Rate of Inventory Turnover

1.4.1. Cost of goods sold / Average inventory

1.4.1.1. Average inventory = (Beginning inventory + Ending inventory) / 2

1.4.2. Measures how quickly inventory is sold

1.4.3. Higher is desirable

1.4.3.1. Means more profits

### 1.5. Acid-test (Quick) ratio

1.5.1. (Cash + short-term investments +Net current receivables) / Total current liabilities

1.5.1.1. Net current receivables = Accounts receivable - Allowance for uncollectible accounts

1.5.2. Measures ability to pay current liabilities with current assets

1.5.3. In general, >1.0 is safe

1.5.3.1. It depends on company too. Wal-Mart has a Quick ratio of 0.2 but it is fine.

### 1.6. Days' Sales in Receivables

1.6.1. Average net receivables / Net sales revenue * 365

1.6.1.1. Average net receivables = (Beginning net receivables + Ending net receivables) / 2

1.6.1.2. Net sales revenue = Sales revenue - Sales returns and allowances - Sales discounts

1.6.2. Measures how many days it takes to collect the average level of receivables

1.6.3. Shorter the period, the faster cash is available, and vice versa

## 2. ACCOUNTING EQUATION Asset = Liability + Owner's Equity

### 2.1. Asset (Norm. Bal. -> Debit)

2.1.1. Contra-asset

2.1.1.1. Accumulated depreciation

2.1.1.2. Allowance for uncollectible accounts

2.1.2. Cash

2.1.3. Accounts receivable (A/R)

2.1.4. Notes receivable

2.1.5. Prepaid expenses

2.1.6. Property (land, building)

### 2.2. Liability (Credit)

2.2.1. Accounts payable (A/P)

2.2.2. Notes payable

2.2.3. Accrued liabilities

2.2.3.1. Unearned revenue

2.2.3.2. Interest payable

2.2.3.3. Salary payable

### 2.3. Owner's Equity (Credit)

2.3.1. Increase

2.3.1.1. Revenue (Credit)

2.3.1.1.1. Contra-revenue

2.3.1.1.2. Sales

2.3.1.1.3. Service

2.3.1.1.4. Interest

2.3.1.2. Owner's investment

2.3.2. Decrease

2.3.2.1. Expense (Debit)

2.3.2.1.1. Rent

2.3.2.1.2. Salary

2.3.2.1.3. Utilities

2.3.2.1.4. Supplies

2.3.2.1.5. Cost of goods sold

2.3.2.2. Owner's withdrawal

## 3. Principles

### 3.1. GAAP Principles

3.1.1. Entity concept

3.1.1.1. Each accounting entity is stands apart as a separate economic unit

3.1.2. Reliability (objectivity) concept

3.1.2.1. Accounting information must be verifiable

3.1.3. Cost principle

3.1.3.1. Record costs at their actual value, not at the value you think is worth

3.1.4. Going-concern concept

3.1.4.1. Assume entity will remain in operation

3.1.5. Stable-monetary-unit concept

3.1.5.1. Assume there is no inflation

### 3.2. Accounting Principles

3.2.1. Accrual vs. Cash-basis

3.2.1.1. Accrual accounting

3.2.1.1.1. Correct way

3.2.1.1.2. Accounting is done when the transaction occurs

3.2.1.2. Cash-basis accounting

3.2.1.2.1. Accounting is done only when cash is exchanged

3.2.1.2.2. Only have Revenue and Expense accounts

3.2.2. Accounting period

3.2.2.1. Yearly/fiscal yearly

3.2.2.2. Interim periods

3.2.2.2.1. Quarterly

3.2.2.2.2. Monthly

3.2.3. Revenue principle

3.2.3.1. When: revenue recorded when it has been earned, not before

3.2.3.2. Amount: actual cash value of the item transacted

3.2.4. Matching principle

3.2.4.1. 1. Measure all expense incurred during period

3.2.4.2. 2. Match expenses against revenues of the period

3.2.4.3. Goal: find net income or loss during period

## 4. What?

### 5.1. Prepaid (cash now, exp/rev later)

5.1.1. Expense

5.1.1.1. a. Cash- (Cr) -> Asset+ (Dr)

5.1.1.2. Adjusting entry: b. Asset- (Cr) -> Expense+ (Dr)

5.1.1.3. Prepaid rent

5.1.1.4. Supplies

5.1.2. Revenue

5.1.2.1. a. Liability+ (Cr) -> Cash+ (Dr)

5.1.2.2. Adjusting entry: b. Revenue+ (Cr) -> Liability- (Dr)

5.1.2.3. Unearned revenue

### 5.2. Accruals (exp/rev now, cash later)

5.2.1. Expense

5.2.1.1. a.Liability+(Cr)->Expense+(Dr)

5.2.1.2. Adjusting entry: b. Cash- (Cr) -> Liability- (Dr)

5.2.1.3. Interest exp. (i.e. loan interest)

5.2.1.4. Salary expense

5.2.2. Revenue

5.2.2.1. a.Revenue+ (Cr) -> Asset+ (Dr)

5.2.2.2. Adjusting entry: b. Asset- (Cr) -> Cash+ (Dr)

5.2.2.3. Interest rev. (i.e. bank interest)

### 5.4. Depreciation

5.4.1. Dr. Depreciation Expense+ (expense)

5.4.2. Cr. Accumulated Depreciation+ (contra-asset; thus +)

5.4.3. Similar to the Prepaid Expense adjusting entry

5.4.4. Assets are marked at book value, that's why we use Accumulated Depreciation

### 5.5. Inventory Shrinkage

5.5.1. Dr. Cost of Goods Sold+ (expense)

5.5.2. Cr. Inventory- (asset)

5.5.3. Adjustment done for missing inventory due to theft or error

## 6. Accounting Cycle

### 6.1. During the Period

6.1.1. 1. Journalize Entries

6.1.1.1. 3 Questions + Map

6.1.1.1.1. a. What are the accounts involved?

6.1.1.1.2. b. Increase or decrease?

6.1.1.1.3. c. Debit or credit?

6.1.2. 2. Post to Ledger

6.1.2.1. Posting to the T-accounts

6.1.3. 3. Prepare Trial Balance (unadjusted)

6.1.3.1. Part of the Accounting Worksheet

6.1.3.2. Balance of the accounts during the period

6.1.3.3. NOT a financial statement

6.1.3.4. p.77 ex.2-12

### 6.2. At the End of Period

6.2.1. 1. Prepare Adjusted Trial Balance

6.2.1.1. Part of the Accounting Worksheet

6.2.1.2. p.198 ex.4-2 to 4-6

6.2.1.3. p.143 ex.3-10

6.2.2. 2. Prepare Statements

6.2.2.1. a. Income Statement

6.2.2.1.1. Multi-step

6.2.2.1.2. Single-step

6.2.2.2. b. Statement of Owner's Equity

6.2.2.2.1. p.202 ex.4-7

6.2.2.3. c. Balance Sheet (unclassified)

6.2.2.3.1. p.202 ex.4-7

6.2.2.4. d. Statement of Cash Flow

6.2.2.4.1. How to prepare this is not tested

6.2.2.4.2. p.20 ex.1-8

6.2.4. 4. Close Accounts

6.2.4.1. Closing involves owner's equity only

6.2.4.2. Income Summary Account

6.2.4.2.1. Left (debit) = Expenses

6.2.4.2.2. Right (credit) = Revenues

6.2.4.3. Steps

6.2.4.3.1. a. Close Revenue to Income Summary

6.2.4.3.2. b. Close Expenses to Income Summary

6.2.4.3.3. c. Compute Income Summary Balance

6.2.4.3.4. d. Close Income Summary to Capital

6.2.4.3.5. e. Close Withdrawals to Capital

6.2.4.3.6. f. Compute Capital Balance

6.2.4.4. p.204 ex.4-9

6.2.5. 5. Prepare Post-closing Trial Balance

6.2.5.1. Part of Accounting Worksheet

6.2.5.2. p.207 ex.4-11

6.2.5.3. p.198 ex.4-5

6.2.6. 6. Classify Assets and Liabilities

6.2.6.1. Current

6.2.6.1.1. Can be liquidated (converted to cash) or paid within 12 months

6.2.6.1.2. Assets

6.2.6.1.3. Liabilities

6.2.6.2. Long-Term

6.2.6.2.1. Anything that is not current is long-term :)

6.2.6.2.2. Assets

6.2.6.2.3. Liabilities

6.2.7. 7. Prepare Classified Balance Sheet

6.2.7.1. Account format

6.2.7.1.1. p.209 ex.4-12

6.2.7.2. Report format

6.2.7.2.1. p.209 ex.4-13

## 7. Merchandising

### 7.1. Perpetual (incomplete)

7.1.1. Purchase

7.1.2. Sales

7.1.3. Cost of Goods Sold

7.1.3.1. No. of units sold * Unit Cost

7.1.3.2. Costing methods (to obtain unit cost)

7.1.3.2.1. Specific unit cost

7.1.3.2.2. Average cost

7.1.3.2.3. First-in, first-out (FIFO) cost

7.1.3.2.4. Last-in, first-out (LIFO) cost

### 7.2. Periodic

7.2.1. Purchase

7.2.1.1. Purchases are not recorded into an Inventory account

7.2.1.1.1. Rather, there are separate accounts for Purchases, Purchase Discounts, Purchase Returns and Allowances and Freight In

7.2.1.2. Ending inventories are simply brought over to the next period

7.2.1.2.1. There is no actual Inventory account to keep track of the current inventory

7.2.1.3. pp.305-306

7.2.2. Sales

7.2.2.1. Same as perpetual, except there is no accompanying entry to Inventory/Cost of Goods Sold

7.2.3. Cost of Goods Sold

7.2.3.1. Cost of Goods Available - Ending inventory

7.2.4. Unit Cost

7.2.4.1. Purchase price - Purchase discounts

### 7.3. Credit Terms

7.3.1. Purchases usually paid on account, then paid later in cash

7.3.2. Usually stated as: x/y

7.3.2.1. x = % discount

7.3.2.1.1. n = net (no discount)

7.3.2.2. y = cash payment due in days

7.3.2.2.1. eom = end of month

### 7.4. Freight

7.4.1. In (for purchases)

7.4.1.1. Transportation cost on purchased goods

7.4.1.1.1. Thus, applies only to the buyer

7.4.2. Out (for sales)

7.4.2.1. Transportation cost on goods sold

7.4.2.1.1. Thus, applies only to the seller

7.4.3. FOB (free on board)

7.4.3.1. Shipping point

7.4.3.1.1. Buyer owns goods while in transit

7.4.3.2. Destination

7.4.3.2.1. Seller owns goods while in transit

### 7.5. Gross Profit Method

7.5.1. Used to estimate inventory if some force majeure occurs

7.5.2. a. Estimate gross profit

7.5.2.1. Past usual Gross Profit Percent * Current Sales Revenue

7.5.3. b. Estimate cost of goods sold

7.5.3.1. Current Sales Revenue - Estimated Gross Profit

7.5.4. c. Estimate ending inventory

7.5.4.1. Cost of Goods Available - Estimated Cost of Goods Sold

### 7.6. Closing

7.6.1. Closing is done by matching the value in the Inventory account against the value of the actual inventory on hand

7.6.2. Lower-of-Cost-or-Market Rule (LCM)

7.6.2.1. Demonstrates accounting conservatism

7.6.2.2. Requires inventory to be reported at the lower of:

7.6.2.2.1. Historical cost of inventory

7.6.2.2.2. Market value of inventory

7.6.3. Errors

7.6.3.1. Errors in the counting of actual inventory on hand

7.6.3.1.1. Understated

7.6.3.1.2. Overstated

7.6.3.1.3. Only Cost of Goods Sold, Gross Profit and Net Income are affected

7.6.3.1.4. Simply remember that Gross Profit and Net Income follows the Ending Inventory's under or overstatement

### 7.7. Principles

7.7.1. Consistency

7.7.1.1. Same accounting methods from period to period

7.7.2. Disclosure

7.7.2.1. Report enough information for outsiders to make wise decisions about the company

7.7.3. Materiality

7.7.3.1. Account only for significant items—"material"—items that may cause someone to change a decision

7.7.4. Accounting Conservatism

7.7.4.1. Goal: to report realistic figures

7.7.4.2. Exercise caution in reporting figures

### 7.8. Terminology

7.8.1. Net Sales Revenue (or simply "Net Sales")

7.8.1.1. Sales revenue - Sales returns and allowances - Sales discounts

7.8.2. Gross Profit

7.8.2.1. Net sales revenue - Cost of goods sold

7.8.3. Cost of Goods Available

7.8.3.1. Beginning inventory + Net purchases

7.8.4. Ending Inventory (Actual)

7.8.4.1. Obtaining the actual number of units on hand * Unit Cost

## 8. Receivables (incomplete)

### 8.1. On Account

8.1.1. Purchase

8.1.1.1. Paid

8.1.2. Revenue

8.1.2.1. Collected

## 9. Journals

### 9.1. Sales

9.1.1. Abbrev. S

9.1.2. For sales on account

### 9.2. Purchases

9.2.1. Abbrev. P

9.2.2. For purchases on account

### 9.3. Cash receipts

9.3.1. Abbrev. CR

9.3.2. For cash receipts

### 9.4. Cash payments

9.4.1. Abbrev. CP

9.4.2. For cash payments

### 9.5. General

9.5.1. Abbrev. J

9.5.2. For all other transactions