Accounting 201 Final Exam Review: Comprehensive Study Notes

Chapter 1: Introduction to Accounting Principles

Types of Business Organizations

Accounting recognizes several forms of business organizations, each with unique characteristics and implications for financial reporting.

• Sole Proprietorship: Owned by one individual; owner has unlimited liability.

• Partnership: Owned by two or more individuals; partners share profits and liabilities.

• Corporation: Separate legal entity; ownership divided into shares; limited liability for shareholders.

Basic Accounting Principles

Understanding foundational accounting principles is essential for accurate financial reporting.

• Matching Principle: Expenses are matched with revenues in the period in which they are incurred.

• Historical Cost Principle: Assets are recorded at their original cost.

• Entity Principle: Business transactions are separate from the owner's personal transactions.

Financial Statements

Financial statements provide a summary of a company's financial performance and position.

• Income Statement: Reports revenues and expenses to show net income or loss.

• Balance Sheet: Shows assets, liabilities, and shareholders' equity at a specific point in time.

• Statement of Retained Earnings: Explains changes in retained earnings over a period.

• Statement of Cash Flows: Details cash inflows and outflows from operating, investing, and financing activities.

Accounting Equation

The accounting equation is the foundation of double-entry bookkeeping.

• Equation: $\text{Assets} = \text{Liabilities} + \text{Stockholders' Equity}$

• Application: Every transaction affects at least two accounts, maintaining the balance of the equation.

Chapter 2: Transaction Analysis

Journal Entries

Journal entries record business transactions in the accounting system.

• Debit and Credit Rules: Debits increase assets and expenses; credits increase liabilities, equity, and revenue.

• Normal Balances: Assets and expenses have debit balances; liabilities, equity, and revenue have credit balances.

Accounting Cycle

The accounting cycle is the process of recording and processing all financial transactions.

• Transaction analysis

• Journalizing

• Posting to ledger

• Trial balance preparation

• Adjusting entries

• Financial statement preparation

• Closing entries

Chapter 3: Accrual Accounting Concepts

Adjusting Entries

Adjusting entries ensure that revenues and expenses are recognized in the correct accounting period.

• Prepaid Expenses: Expenses paid in advance; require adjustment as they are used.

• Deferred Revenue: Cash received before revenue is earned; adjusted as revenue is recognized.

• Accrued Expenses: Expenses incurred but not yet paid.

• Accrued Revenue: Revenue earned but not yet received.

Accrual vs. Cash Basis Accounting

Two primary methods for recognizing transactions in accounting.

• Accrual Basis: Revenues and expenses are recognized when earned or incurred, not when cash is exchanged.

• Cash Basis: Revenues and expenses are recognized only when cash is received or paid.

Chapter 4: Merchandising Operations

Inventory Systems

Merchandising companies use inventory systems to track goods for sale.

• Perpetual System: Inventory records are updated continuously.

• Periodic System: Inventory records are updated at the end of the accounting period.

Journal Entries for Inventory Transactions

• Sales transactions

• Sales returns and allowances

• Sales discounts

• Purchase of inventory (on account and cash)

• Purchase returns and allowances

Income Statement Formats

Companies may use single-step or multiple-step income statements.

• Single-Step: All revenues and gains are totaled, all expenses and losses are totaled, and net income is calculated.

• Multiple-Step: Separates operating revenues and expenses from non-operating items, showing gross profit and operating income.

Classified Balance Sheet

A classified balance sheet organizes assets and liabilities into current and non-current categories.

• Current Assets: Expected to be converted to cash or used within one year.

• Non-Current Assets: Long-term investments, property, plant, and equipment.

• Current Liabilities: Obligations due within one year.

• Non-Current Liabilities: Long-term obligations.

Chapter 5: Inventory

Inventory Costing Methods

Different methods are used to assign costs to inventory and cost of goods sold.

• FIFO (First-In, First-Out): Oldest inventory costs are assigned to cost of goods sold first.

• LIFO (Last-In, First-Out): Most recent inventory costs are assigned to cost of goods sold first.

• Average Cost: Cost of goods available for sale is averaged over all units.

• Specific Identification: Actual cost of each item is assigned to cost of goods sold.

Inventory Valuation

• Lower of Cost or Market: Inventory is reported at the lower of its historical cost or market value.

• Gross Profit Method: Used to estimate ending inventory based on gross profit percentage.

Chapter 6: Internal Controls and GAAP vs IFRS

GAAP vs IFRS

Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) are two major accounting frameworks.

• GAAP: Used primarily in the United States; rules-based.

• IFRS: Used internationally; principles-based.

• Key Differences: Treatment of inventory, revenue recognition, and asset valuation.

Internal Controls

Internal controls are processes designed to safeguard assets and ensure reliable financial reporting.

• Objectives: Safeguard assets, enhance accuracy and reliability of accounting records.

• Elements:

  • Control environment

  • Risk assessment

  • Control activities (e.g., authorizations, verifications)

  • Information and communication

  • Monitoring

Fraud Triangle

The fraud triangle explains the factors that lead to fraudulent behavior.

• Pressure: Financial or personal incentives

• Opportunity: Weak internal controls

• Rationalization: Justification of dishonest actions

Chapter 7: Receivables and Bank Reconciliation

Bank Reconciliation

Bank reconciliation matches the company's cash records with the bank statement to identify discrepancies.

• Adjust for outstanding checks, deposits in transit, bank errors, and company errors.

• Prepare journal entries to correct the company's records.

Estimating Uncollectible Accounts

Companies estimate uncollectible accounts to account for potential losses from customers who do not pay.

• Direct Write-Off Method: Bad debts are written off when deemed uncollectible.

• Allowance Method: Bad debts are estimated and recorded in the same period as related sales.

Calculating Bad Debt Expense

• Percentage of Sales Method: Bad debt expense is a percentage of credit sales.

• Aging of Accounts Receivable: Bad debt expense is estimated based on the age of receivables.

Journal Entries for Bad Debts

• Debit Bad Debt Expense; Credit Allowance for Uncollectible Accounts

• When an account is written off: Debit Allowance for Uncollectible Accounts; Credit Accounts Receivable

Additional info:

• This review outline covers the major topics from chapters 1-7, which align with the standard Financial Accounting curriculum.

• Topics such as long-lived assets, liabilities, statement of cash flows, and financial statement analysis may be covered in later chapters not included in this outline.