Example questions of what might be on the test

(Exam date: 16/02/24)

Theoretical part 1: Accounting and the Business

Environment
Accounting:
Measures business activities; Processes that data into reports; Communiacates the results
to decision makers

Decision Makers: Financial vs Manegerial Accounting

● Financail Accounting; for external decision makers
- Should I invest; is it profitable; Should we lend money; Cant they pay us back?
- For Investors, Creditors (to whom the business owes money), Tax authorities

● Manegerial Accounting; for internal decision makers

- How big should the budget for production be; Should we expand into a new location;
Comparing actual cost to budgeted cost?
- For managers, ect

GAAP: Generally Accepted Accounting Principles (4

Assumptions)
Accounting guidelines

Economic entity assumption:

“A business's financial activities should be distinct from those of its owners and other
entities.”
- Separate economic entity
- Keeping personal and business transactions separate

Cost Principle:
“Assets should be recorded at their original cost”
- Historical Cost (what we paid then, not what it might be worth now)

Going concern assumption:

“Assumes that a business will continue its operations indefinitely”
- Assumption that the entity will not be liquidated in the near future.

Monetary unit assumption:

“Financial transactions should be recorded in a stable and universally accepted currency
 - Allowing consistency and comparability between different financial statements

Accounting Equation
The accounting equation is the basic tool of accounting, measuring the resources of the
business and the claims to those resources.

Assets = Liabilities + Equity

Assets:
“Economic resource that is expected to benefit the business in the future”
- Cash; Supplies; Furniture; Land, ect

Liabilities:
Debts that are owed to creditors (payable)
- Account payable; Notes Payable; Salaries Payable

Equity:
The owners’ claims to the assets of the business (also called owner’s equity)
Increase: Owner’s capital (Owners contribution); Revenues
Decrease: Owner’s Withdrawals (dividends); Expenses
Theoretical part 2: Recording Business
Transactions

Examples of accounts (def. of ledger)

A Ledger is a record holding all the accounts of a business, the changes in those accounts,
and their balances.

Double-Entry Accounting (The T-Account)

Shortened form of the Ledger is a T-Account:

Normal Balance of an Account:

All accounts are summarized on one side of the T-account, called the normal balance.
- An account’s normal balance appears on the increase side of the account.

How Do You Record Transactions

Source Documents - The Origin of the Transactions:
Accountants use source documents to provide evidence and data
for recording transactions.
- Purchase invoices; Bank checks; Sales invoices

Journaling and Posting Transactions:

 - Transactions are recorded in a journal; the record of the transactions in date order
- Transferring data from the journal to the ledger is called posting

Posting:

What Is the Trial Balance

A trial balance is a list of the ledger accounts with their balances at a point in time.
- asset accounts are listed first, followed by liabilities, and then equity

Debt Ratio
The debt ratio shows the proportion of assets financed with debt
- Used to evaluate a business’s ability to pay its debts and to determine if the
company has too much debt

Dept Ratio = Total Liabilities / Total Assets

Theoretical part 3: The Adjusting Process

Cash Basis Accounting and Accrual Basis Accounting

Cash basis accounting:
- Revenue is recorded when cash is received
- Expenses are recorded when cash is paid
- Not allowed under GAAP

Accrual basis accounting:

- Revenue is recorded when cash is earned
- Expenses are recorded when incurred
- Used by most businesses

Good explanation:
https://www.youtube.com/watch?v=GEZZftO_VrE&ab_channel=LeilaGharani

The Time Period Concept

Time Period Concept:
- Business activities are sliced into small time segments
- Financial statements can be prepared monthly, quarterly, or annually

Fiscal year:
- Any 12-month accounting period
- Often coincides with a calendar year

The Revenue Recognition Principle

The revenue recognition principle dictates when to record revenue and the amount of
revenue to record.
- Record revenue when earned (Accrual basis accountingAccrual basis accounting
- When a good has been delivered / a service has been performed
- The earning process is complete
- May be different from cash collections
- Revenue is based on the actual selling price of the item or service

The Matching Principle

The matching principle guides accounting for expenses.
- Expenses are recorded when they are incurred during the period
- Expenses are matched against the revenue of the period.
 - For example, record rent expense for January against January revenues,
even if the rent was paid in December

What are Adjusting Entries, and How Do We Record Them

Adjusting entries can be divided into two basic categories:

Deferrals: Accruals:

- Deferred Expenses - Accrued Expenses

- Deferred Revenues - Accrued Revenues

Deferred Expenses:
-
Advance payments of future expenses
-
Treated as assets until used
-
Recognized as an expense by an adjusting journal entry when the prepayment is
used
- Prepaid Rent; (usage of) Office supplies; Depreciation (of assets)
Example:
1.

2.
Depreciation:
Depreciation is the allocation of a plant asset’s cost over its useful life

Plant assets:
- Long-lived, tangible assets
- Used in the operations of the business
- Value and usefulness decline as the assets are used
- Similar to deferred expenses
- Paid for when acquired
- Used up over time
- Usage recorded as Depreciation Expense

Residual Value:
- The expected value of a depreciable asset at the end of its useful life
- The straight-line method allocates an equal amount of depreciation each year

Accumulated Depreciation:
The Accumulated Depreciation account is the sum of all depreciation expense recorded
for the depreciable asset to date
- Accumulated Depreciation is a contra account; therefore, the account balance is the
opposite of the normal balance of the related asset account.

Cost - Accumulated Depreciation = Book Value

Example:
Companies total Plant Assets: (as of the time period)

Deferred Revenue:
- Occurs when a company receives cash before it does the work or delivers a
product
- Is a liability because the business owes the customer the product, the service, or a
refund
- Upon performance or delivery, deferred revenue is converted to earned revenue

Example:
Accrued Expenses:
Accrued expenses are expenses a business has incurred but has not yet paid
- Salaries; Interest; Utilities
- Equity goes down, and Liability grows

Accrued Revenue:
- A company performs a service but has not yet collected cash
- A company delivers a product but has not yet collected cash
What is the Purpose of the Adjusted Trial Balance, and How Do
We Prepare it
At the end of the fiscal period, an adjusted trial balance is prepared
- Summary of all accounts with adjusted balances
- The purpose is to ensure total debits equal total credits
- The adjusted trial balance includes the balances after posting the adjusting
journal entries
- Prepare the financial statements from the adjusted trial balance

How Could a Worksheet Help in Preparing Adjusting Entries

and the Adjusted Trial Balance
A worksheet is an internal document that helps summarize data for the preparation of the
financial statements.
Four sections
- Account names; Unadjusted trail balance; Adjustments; Adjusted trail balance
Alternative Treatment of Recording Deferred Expenses and
Deferred Revenues
Alternative approaches
Deferred expense:
1. Rather than record the prepayment of an expense as a current asset, record the
prepayment as an expense on the date of payment.
2. At the end of the period, if any of the expense remains “unused,” then adjust some of
it into the prepaid asset account.

Deferred Revenue:
1. Rather than record the early cash receipt from a customer as a current liability, record
the cash receipt as a revenue on the date of receipt.
2. At the end of the period, an adjustment is made for the portion of revenue not earned
in the period. (Unearned Revenue)

Theoretical part 4: Completing the Accounting

Cycle

How Do We Prepare Financial Statements

Income Statement:
Reports revenues and expenses and calculates net income or loss for the period

Statement of owner’s equity:

Shows how capital changed during the period

Balance sheet:
Reports assets, liabilities, and stockholders’ equity as of the last day of the period

Relationships Among the Financial Statements

The different financial statements relate to each other:
- Net income or net loss from the income statement flows to the statement of owner’s
equity
- Ending Capital from the statement of owner’s equity flows to the balance sheet

Classified Balance Sheet

A classified balance sheet places each asset and each liability into a specific category
- Assets are shown in order of liquidity (= how quickly an account can be converted to
cash)
- Liabilities are classified as current (due within one year) or long term (due after one
year)

Assets
Current Assets:
Converted to cash or used within 12 months or within the operating cycle.

Long-term Assets:
Not converted to cash or used up within the operating cycle or one year.
- Long-term investments; Plant assets; Intangible assets

Liabilities
Current liabilities:
Current liabilities must be paid either with cash or with goods and services within one year
or within the entity’s operating cycle
- Accounts Payable; Salaries Payable; Unearned Revenue

Operating cycle:
The operating cycle is the time span during which cash is paid for goods and services, which
are then sold to customers, from whom the business collects cash.

Long-term liabilities:
Liabilities that do not need to be paid within one year or within the operating cycle.

Owner’s Equity
Owner’s equity represents the owner’s claims to the assets of the business.
- Reflects the owner’s contributions to the business, net income or net loss of the
business, and owner’s withdrawals
- Represents the amount of assets left over after the corporation has paid its liabilities.
How Could a Worksheet Help in Preparing Financial
Statements?

What Is the Closing Process, and How Do We Close the

Accounts?
The closing process zeros out all revenue and expense accounts in order to measure
each period’s net income separately from all other periods.

Temporary Accounts:
Revenues; Expenses, Owner’s Withdrawals

Permanent Accounts:
Assets; Liabilities; Owners’s Capital

The Closing Process

Closing entries:
- Transfer revenues, expenses, and Owner-Withdrawals balances to the Owner,
Capital account
(Close all accounts in the income statement → into an income summary → close income
summary into Owner. Capital → close Owner, Withdrawal into Owner, Capital → get Ending
Balance
Revenues and expenses may be transferred first to an account titled Income Summary
- The Income Summary account summarizes the net income (or net loss) for the
period

Examples:

More in presentation

Post-Closing Trial Balance

The accounting cycle ends with a post-closing trial balance
- A list of the accounts and their balances at the end of the period, after journalizing
and posting the closing entries
- Includes only permanent accounts (= accounts that you don't close at the end of
your accounting period)
What Is the Accounting Cycle

How Do We Use the Current Ratio to Evaluate Business

Performance?
The current ratio measures a company’s ability to pay its current liabilities with its
current assets.

Current ratio = Total current assets / Total current liabilities

What Are Reversing Entries?

- Special journal entries that ease the burden of accounting for transactions in a later
period.
- The opposite of certain adjusting entries
- Not required by GAAP
- Used for convenience and to save time

Examples in presentation