FNEC-1600 Study Guide - Midterm Guide: Financial Accounting Standards Board, Limited Liability, Retained Earnings
15 May 2018
School
Department
Course
Professor
FNEC 1600
Test 1 – Review
Multiple Choice Topics (10 questions; 20 points)
1) What is GAAP and what group is responsible for it?
Standards used – Generally Accepted Accounting Principles (GAAP); maintained by the Financial
Accounting Standards Board (FASB).
2) Characteristics of various forms of business
1) Sole Proprietorships (70% of all businesses)
Advantages: Easy to form, not a taxable entity, owners control operations.
Disadvantages: Unlimited liability, limited life, limited financial resources.
2) Partnerships (10% of all businesses)
Advantages: Combine skills and financial resources of multiple owners, not a taxable entity, easy to form
(do need a partnership agreement).
Disadvantages: Mutual agency (actions of one partner binds all partners), unlimited liability, limited life.
3) Corporations (10% of all businesses; 90% of all taxable income)
Advantages: more capital available, easy to transfer ownership, limited liability.
Disadvantages: More difficult to form, higher taxes (it is a taxable entity), double taxation.
3) Know types of accounts included in each of the financial statements prepared and what
each financial statement reports.
Four Primary Financial Statements
1. Balance Sheet – Formal listing of Assets, Liabilities, & Owner’s Equity
a. Formal report of the accounting equation
2. Income Statement – Net Income/Profit earned during a period of time measured with Revenues
earned and Expenses incurred.
3. Statement of Retained Earnings – Reports the change in Retained Earnings for the accounting
period (net income less dividends).
4. Statement of Cash Flows – Reports cash inflows and outflows from three sources; Operating
Activities, Investing Activities, & Financing Activities
4) What the financial ratios we studied tell you about a company and how they are used.
Financial Ratios
1) Working Capital: measure of liquidity
Working Capital = Current Assets – Current Liabilities
• Liquidity ratio: measures a company’s ability to pay debt
2) Current Ratio: measure of liquidity used when comparing companies
Current Ratio = Current Assets / Current Liabilities
• Result itself tells you nothing. Need to compare with other similar companies.
• Liquidity ratio: measures a company’s ability to pay debt
3) Net Profit Margin: measures management’s ability to control expenses and generate profits
Net Profit Margin = Net Income / Sales Revenue
find more resources at oneclass.com
find more resources at oneclass.com
5) Be familiar with the accounting equation and how various activities affect the accounting
equation
Assets = Liabilities + Owners’ Equity
6) Qualitative characteristics of accounting information, accounting assumptions, and
accounting principles
The Conceptual Framework (the foundation of GAAP)
Qualitative Characteristics of Accounting Information:
1. Relevance – makes a difference in a decision
2. Faithful Representation – complete, unbiased, and accurate
3. Comparable – to similar companies or to other accounting periods
4. Verifiable – independent parties can reach a consensus on the measurement of
an item.
5. Timely – available when needed for decision making
6. Understandable – users can comprehend the meaning of the information
Assumptions:
1. Economic Entity – the company is accounted for separately from its owners’
personal transactions.
2. Going Concern (Continuity) – the company will continue to operate long
enough to meet its existing commitments.
• Auditors are required to revalue assets at a liquidation value if it looks like the company might go
out of business. If the company went out of business today, this is how much cash they would
have to fulfill liabilities. Cannot let readers of financial statements assume that the company will
be able to continue its operations.
3. Time Period – the life of the company is divided into time periods for reporting
purposes (i.e. monthly, quarterly, annually).
4. Monetary Unit – For our class, all transactions will be measured in U.S. currency.
• won’t go on the financial statements if you can’t measure it in that unit that you are reporting in
• can’t measure employees, for example
Principles:
1. Historical Cost – items are recorded and maintained at their initial cost.
• If we acquire land, it stays on the books at the price at which we acquired it. The value of land
changes, but the price doesn’t change on the books. This is a flaw in accounting principles
because you can’t take a collateral out against it at a higher price even if it gains value. Appraisal
is also subjective. Balance we have on there for land isn’t relevant: you can’t use it to help make a
decision.
2. Revenue Recognition – revenue is recorded in the accounting period when earned, not when cash is
received.
• In what accounting period will revenue hit the income statement? Any revenue that the company
has earned, not what they have received in cash. If I sold it, it’s a revenue, and legally the
customer owes me the tax. Doesn’t matter if the customer paid you back, even if they paid you
early. If it’s sold in January, that’s when it hits the income statement.
3. Matching - Expenses are to be recorded in the same period for which those expenses generate
revenues. In other words, record revenues and the related expenses in the same accounting period.
find more resources at oneclass.com
find more resources at oneclass.com
• If I earn a revenue in January, I want all the expenses associated with that to also be recorded in
January. 1/12 of an annual insurance fee will go on each monthly statement, for example. Cost of
goods sold doesn’t go on the income statement until merchandise gets sold.
4. Conservatism – avoid overstating assets or income, but remain unbiased.
7) Know the difference between cash basis and accrual basis accounting in terms of when
revenues and expenses are recognized.
Accrual vs. Cash-Basis Accounting
1. Cash basis – NOT GAAP – Revenues and expenses are recognized as
cash changes hands.
2. Accrual basis – GAAP – is based on the revenue recognition principle which requires revenues to
be recorded when: (a) Sales has been made or service performed (earnings process is substantially
complete and (b) collectability of cash is reasonably assured.
This can be extended to apply to expenses. Expenses are recorded as INCURRED without regard to
when cash changes hands.
The accrual basis supports the matching principle – Expenses are to be recorded in the same period
for which those expenses generate revenues. In other words, record revenues and the related expenses
in the same accounting period.
8) The effect on financial statements when an adjusting entry is omitted
Description of Problems
1) Calculation of financial statement totals or subtotals (20 points)
2) Calculation of financial statement totals or subtotals (16 points)
3) Given beginning account balances along with information related to current year results,
determine ending balances (this take into account how activities affect the accounting
equation) (4 points)
4) Prepare journal entries for routine daily transactions (15 points)
5) Prepare typical adjusting journal entries (25 points)
Notes:
1. Show work and/or calculations to maximize points
2. Bring a calculator (phones cannot be accessible)
3. No questions during the test
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Standards used generally accepted accounting principles (gaap); maintained by the financial. Accounting standards board (fasb): characteristics of various forms of business, sole proprietorships (70% of all businesses) Advantages: easy to form, not a taxable entity, owners control operations. Disadvantages: unlimited liability, limited life, limited financial resources: partnerships (10% of all businesses) Advantages: combine skills and financial resources of multiple owners, not a taxable entity, easy to form (do need a partnership agreement). Disadvantages: mutual agency (actions of one partner binds all partners), unlimited liability, limited life: corporations (10% of all businesses; 90% of all taxable income) Advantages: more capital available, easy to transfer ownership, limited liability. Disadvantages: more difficult to form, higher taxes (it is a taxable entity), double taxation: know types of accounts included in each of the financial statements prepared and what each financial statement reports. Four primary financial statements: balance sheet formal listing of assets, liabilities, & owner"s equity.
