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111 Cards in this Set
- Front
- Back
2 types of primary users? |
1. internal users 2. external users |
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who are internal users? which 4 questions do they answer with financial info? |
internal users: -people who work in the company -plan, run & organize company 4 questions: 1. enough to pay bills? 2. how many employees can we afford? 3. what price maximizes profit? 4. which product line is more profitable? |
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2 types of external users & their uses for accounting info? |
1. investors -is the company earning enough to give return on investment? -should we buy, hold, or sell ownership? 2. lenders & other creditors -will the company be able to pay its debts? -risk assessment : will i get my money back in time? |
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3 forms of business organizations & their owner(s) |
1. sole proprietorship : single owner 2. partnership : multiple owners 3. corporation : legal entity owned by shareholders |
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pros & cons of proprietorships |
no legal distinction between business & owner so: -proprietorship limited to life of owner +owner receives all profit +small start-up capital & easy to set up +full control -unlimited liability (personally liable for all business debts |
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taxing proprietorship? |
taxed on owner's personal income tax return |
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Reporting Entity Concept & who does it apply to? |
separation of personal and business records applies to all business types |
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characteristics of partnerships: |
+greater economic resources, skills & knowledge -sharing of profits ( in formal contract) -+can have unlimited or limited liability (depends on contract) |
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how are partnerships taxed? |
each partner reports their share of profits as self-employment income & are taxed on each partner's personal income tax return |
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pros of corporations |
separate legal entity so: +indefinite life +easy to transfer ownership (trade stocks) +easy to raise capital +limited liability for shareholders (not responsible for corporate debts unless personal guarantee) |
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Which type of corporations use International Financial Reporting Standards (IFRS)? |
Publicly traded corporations use IFRS |
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which accounting standards to private corporations follow? |
private corporations have a choice between IFRS and Accounting Standards for Private Enterprises (ASPE) |
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3 types of business activities? |
1. financing 2. investing 3. operating |
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financing activities |
raising funds! can be done in two ways: 1. debt financing (borrowing $$) 2.equity financing (issuing/selling shares) |
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is money from issuing shares revenue? |
no! it is equity |
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is money paid as dividends an expense? |
no! |
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Investing activities |
purchasing long lived/ fixed assets that the company needs in order to operate |
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are short run investments counted as investing activities? |
no! short run investments: operating activities -incurred as revenue producing activities |
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operating activities |
day-to-day activities including revenue & expense related accounts |
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3 types of businesses? |
1. Manufacturing 2. Merchandising 3. Service |
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what does a manufacturing business do? |
buy raw materials and make goods -lots of money invested in production |
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merchandising business |
buy goods from manufacturing business and sell them |
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key characteristic of service businesses? |
no inventory! |
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what does a cash flow statement tell us? |
where money came from and where it went/how it was used |
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income statements vs statements of equity |
income statement starts fresh, but statement of equity starts from previous year/statement's ending value |
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assets |
-resources that provide economic benefit -what a company owns -increase with debits |
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liabilities |
-outsider claims -what a company owes -increases with credits -negative economic value |
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shareholder's equity |
-insider claims -increase with credits -expenses decrease equity -revenues increase equity |
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2 components of shareholder's equity |
1. share capital 2. retained earnings |
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how to calculate retained earnings (4 steps) |
1. start with previous retained earnings/loss 2. add net income 3. subtract dividends 4. new retained earnings |
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what does an income statement tell us? |
revenue - expenses = net income/loss tells us if the business is profitable |
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3 levels of the conceptual framework |
1. objectives ( the why) 2. elements + qualitative characteristics 3. foundational principles and conventions (the how) |
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2 overall objectives of financial reporting |
to provide users information that is: 1. useful 2. decision relevant |
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information symmetry |
equally informed users |
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moral hazards |
accountants & managers use expert knowledge to act in self-interest |
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2 fundamental qualitative characteristics |
1. relevant 2. representational faithfulness (reliable) |
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characteristics of relevant info (5) |
-make an impact on decision -predictive value -feedback/confirmatory value -materiality (importance: information that is included makes a difference) |
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characteristics of representational faithfulness/reliable info (4) |
-neutral (no bias/not manipulated) -complete -free from material error -substance over form |
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4 qualities that enhance relevance & reliability ( 4 '-ilities') |
1. Comparability 2. Verifiability 3. Timeliness 4. Understandability |
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comparability |
measuring & reporting info in a similar way allows company to company (intercompany) and year to year (intracompany) comparisons |
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verifiability |
achieving similar results or a consensus regarding the accounting of a transaction -hard numbers easy to verify -soft numbers = more uncertainty |
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timeliness |
info available while it can still make impact (on time, not late!) |
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understandability |
-information of sufficient quality & clarity -reasonably informed users should understand it - enough info to be clear |
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trade-offs & constraints (2) |
-tough to achieve 100 % reliability & 100% relevance -cost vs benefit (benefit of using info must outweigh cost of providing it) |
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difficulty with cost-benefit relationship |
benefits are more difficult to quantify/measure and the benefits might not be very evident |
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what does comparability increase? |
relevance (sometimes reliability) |
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what does verifiability increase? |
reliability |
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what does timeliness increase? |
relevance but decreases reliability |
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what does understandability increase? |
reliability |
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3 characteristics of assets |
1. economic benefit 2. control over it 3. result from past transaction or event (ex: purchase or donation) |
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3 characteristics of liabilities |
1. represent duty or responsibility 2. obligation / no discretion to avoid it 3. results from past transaction or event |
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what is equity? |
residual interest in assets what is leftover after paying debts |
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3 types of obligations liabilities arise from |
1. contractual (contracts, ex: wages) 2. constructive (from guarantees/warranties/policies) 3. equitable (ethics) |
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revenue vs gains |
revenue: increase in economic resources due to ordinary/regular activities gains: increase in equity from incidental/peripheral activities |
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expenses vs losses |
expenses: decrease in economic resources due to ordinary revenue generating activities losses: decrease in equity (net asses) due to incidental activities |
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what does a balance sheet tell us? |
whether a company relies on debt or equity to finance assets |
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primary focus of accounting information? |
investing and crediting decisions |
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recognition/ derecognition |
including something on statement/ taking something off statement |
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4 recognition/ derecognition principles |
1. economic entity assumption 2. control 3. revenue recognization/ realizable principles 4. matching |
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3 criteria for recognization |
1. probable 2. measurable 3. meet definition of an element ( A, L, E) |
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Economic entity assumption |
-unit of accountability -business is separate & distinct from owners -parent & subsidiary companies are separate legal entities but one economic entity |
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control & 3 characteristics |
decides what should be included in the entity 1. power over investee 2. exposure to returns from involvement with investee 3. ability to affect amount of investee's returns |
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revenue recognization & realization (3 criteria to recognize revenue) |
1. process is complete (risks & rewards passed) 2. measurable (doesnt have to be cash but must be valued in cash) 3. collectible |
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matching |
-expenses matched with revenues they incur -demonstrates cause and effect relationship -assets are expensed
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2 groups of operating expenses (2 types of costs) |
1. product costs -direct relationship to revenue -material, labour, overhead -recognize in period of revenue 2. period costs -no direct relationship to revenue -salaries, admin costs -expense when incurred |
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short fall of cash based accounting |
reliable but not relevant |
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accrual accounting |
includes cash & non-cash transactions -reliable & relevant -but requires assumptions |
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when do we expense inventory? |
when we sell it |
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5 Measurement principles |
1. Periodicity assumption 2. monetary unit assumption 3. going concern assumption 4. historical cost assumption 5. fair value principle |
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measurement |
-accrual accounting involves assumptions -cannot record things unless they are measurable -need to determine acceptable level of uncertainty & disclose it -use appropriate measurement tools |
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periodicity assumption |
artificial time frame -usually one year, one month, one quarter -same time period enhances comparability -but shorter the time frame, the more rushed & the more assumptions needed |
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monetary unit assumption |
-measured in money -assume stability -if cannot put monetary value, we do not include it |
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going concern assumption |
-assume the entity will continue to operate in forseeable future -long enough to fulfill comittments -value at liquidation value if this assumption cannot apply |
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3 assumptions of historical cost principle |
reliable but not always relevant 1. value at a point in time 2. reciprocal exchange (2 way) 3. outside arm's length party (not related) |
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fair value principle |
-price received to sell or paid to transfer at measurement date -more relevant -not always reliable -inactive market: tough to come up with price |
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full disclosure principle |
anything relevant to users should be included in: -body of statements -notes -as supplementary info *disclosure increases relevance but it is costly |
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current vs non-current elements |
expectation to be sold/used/paid within one year (current) or not (non current) |
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intangible assets |
non-current assets with no physical substance *represent privilege or a right ex: goodwill, trademark, copyright, etc |
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when do we depreciate? |
when useful life is NOT indefinite (cant allocate cost over lifetime if we dont know lifetime) |
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carrying amount |
cost of asset - accumulated depreciation |
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accumulated depreciation |
total amount asset has depreciated by until this date * contra asset : deducted from asset btu still in asset section of balance sheet |
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share capital |
investment by shareholders |
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retained earnings |
money kept in the business |
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2 elements in profitability ratios |
1. gross profit= sales - COGS 2. net profit= gross profit - expenses |
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Profitability ratios (5) |
1. gross profit % = gross profit/net sales x100 2. net profit % = net profit/net sales x100 3. return on assets = net profit/ avg total assets x 100 4. Earningsper share = Net Profit aftertax/ number of issued common shares 5. Price Earnings Ratio = market price per share/ earnings per share |
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what do liquidity ratios measure? |
ability to meet ST obligations & unexpected needs for cash |
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liquidity measure & 2 ratios |
1. working capital= current assets - current liabilities 2. current ratio= current assets/current liabilities 3. quick test (acid test)= current assets -inventory - prepaids / current liabilities |
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what does solvency tell us? |
ability to handle debt and pay interest *long term ability to survive |
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solvency ratios (2) |
1. debt to total assets= total liabilities / total assets x 100 2. Free Cash Flow = Net cash provided (used)by operating activities less dividends less net capital expenditures |
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efficiency ratios (4) |
1. receivables turnover= revenue/ accounts receivable 2. average collection period= 365/ receivable turnover 3. inventory turnover= COGS/ inventory 4. Days in inventory: 365/ inventory turnover |
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what type of transactions are recorded? |
economic impact: transactions that change assets, liabilities, or shareholder's equity |
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when are trial balances prepared? |
before financial statements |
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does issuing shares and distributing dividends affect profit? |
technically no, bc they do not appear on the income statement the appear on the statement of changes in equity where they affect retained earnings |
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why are income statement accounts temporary accounts? |
close them out each year so we can start fresh and see how much profit was made per year |
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accounts receivable vs accrued receivable |
Accounts receivable: transaction has occurred on account, notice has been issues Accrued Receivable |
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debit : DEALS |
d- dividends e-expenses a-assets l-losses |
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GRLS: credit |
g-gains r-revenue l-liabilities s-shareholders' equity |
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legal entity vs economic entity |
legal entity: taxed together economic entity: financial statements made together |
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product cost vs period cost |
product costs are matched period costs are expensed |
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accrued receivables vs accounts receivables |
acrrued: no invoice accounts: invoiced |
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when are adjusting entries performed? |
end of the month |
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why do we need adjusting entries? |
-keep accounts up to date -some are only updated at end of month (ex: interest) instead of daily |
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2 types of accounts that usually need adjusting entries ( 2examples of each) |
1. Prepayments -prepaid expenses -unearned revenue 2. Accruals -accrued revenues -accrued expenses |
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what would happen if adjusting entries werent made? |
accounts would be overstated & understated (not reliable or accurate) |
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how to close entries? |
transfer temporary account balances to retained earnings |
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3 types of temporary accounts |
1. expenses 2. revenue 3. dividends |
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3 types of permanent accounts |
1. assets 2. liabilities 3. all shareholders' equity accounts |
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how to close entries? |
do opposite of normal balance and then transfer it to income summary ex: debit revenue account and credit revenue on income summary |
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closing order |
1. revenue 2. expenses 3. income summary 4. dividends |
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how to close income summary? |
cr/dr income summary and then cr/dr retained earnings |
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post-closing trial balance |
balance of all permanent accounts |