Financial Accounting 201: Comprehensive Final Exam Study Guide

Chapter 1: Business, Accounting, and You

Types of Business Organizations

Understanding the different forms of business organizations is foundational in accounting. The main types include:

• Sole Proprietorship: Owned by one individual; simple to establish but owner is personally liable for debts.

• Partnership: Owned by two or more individuals; partners share profits, losses, and liability.

• Corporation: Separate legal entity; owners (shareholders) have limited liability.

Accounting Principles and Measurement

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

• Entity Principle: Business is treated as separate from its owners.

• Revenue Recognition Principle: Revenue is recognized when earned, not necessarily when received.

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.

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

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

Statement of Cash Flows

• Shows the inflows and outflows of cash, categorized into operating, investing, and financing activities.

Example: A sole proprietorship records the purchase of equipment at its purchase price, not its current market value, following the historical cost principle.

Chapter 2: Analyzing and Recording Business Transactions

Journal Entries and the Accounting Cycle

Recording transactions accurately is essential for reliable financial reporting.

• Journal Entries: The initial recording of transactions in chronological order.

• Double-Entry Accounting: Each transaction affects at least two accounts (debits and credits).

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

• Trial Balance: A list of all accounts and their balances at a particular date, used to verify that debits equal credits.

Example: Purchasing supplies for cash is recorded as a debit to Supplies and a credit to Cash.

Chapter 3: Adjusting and Closing Entries

Adjusting Entries

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

• Types of Adjusting Entries:

  • Accrued Revenues

  • Accrued Expenses

  • Deferred Revenues

  • Deferred Expenses

• Accrual vs. Cash Basis Accounting: Accrual basis recognizes revenues and expenses when earned/incurred, not when cash is exchanged.

• Closing Entries: Transfer balances from temporary accounts (revenues, expenses, dividends) to permanent accounts (retained earnings).

• Contra Accounts: Accounts that offset related accounts (e.g., Accumulated Depreciation, Allowance for Uncollectible Accounts).

Example: An adjusting entry for accrued salaries increases Salaries Expense and Salaries Payable.

Chapter 4: Accounting for a Merchandising Business

Merchandising Transactions and Inventory Systems

• Perpetual Inventory System: Inventory records are updated continuously.

• Key Journal Entries:

  1. Sales transactions (two entries: sales revenue and cost of goods sold)

  2. Sales returns

  3. Sales allowances

  4. Sales discounts

  5. Purchases of inventory (on account and cash)

  6. Purchase returns and allowances

  7. Purchase discounts

• FOB Terms: Determines when ownership of goods transfers (FOB shipping point vs. FOB destination).

• Single-Step vs. Multi-Step Income Statement: Multi-step separates operating and non-operating items, providing more detail.

Example: A sale of inventory on account is recorded as a debit to Accounts Receivable and a credit to Sales Revenue, with a second entry debiting Cost of Goods Sold and crediting Inventory.

Chapter 5: Inventory

Inventory Costing Methods

• 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: Weighted average cost per unit is used for all units.

• Specific Identification: Each item is tracked individually.

Inventory Valuation

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

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

Example: If inventory cost is $10,000 and market value is $9,000, inventory is reported at $9,000 under LCM.

Chapter 6: The Challenges of Accounting: Standards, Internal Control, Audits, Fraud, and Ethics

Accounting Standards

• US GAAP vs. IFRS: Know the key differences between these two sets of accounting standards.

Internal Controls

• Objectives: Safeguard assets, ensure reliable financial reporting, promote compliance.

• Components:

  • Control Environment

  • Risk Assessment

  • Control Activities

  • Information and Communication

  • Monitoring

Fraud and the Fraud Triangle

• Fraud Triangle: Opportunity, Pressure, Rationalization.

• Understanding the methods and motivations behind fraud is essential for prevention.

Chapter 7: Cash and Receivables

Bank Reconciliation

• Process of matching the balance per bank statement with the balance per books, adjusting for outstanding checks, deposits in transit, and errors.

Accounting for Bad Debts

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

• Allowance Method: Estimates uncollectible accounts at the end of each period.

• Journal Entries: Debit Bad Debt Expense, credit Allowance for Uncollectible Accounts.

Notes Receivable

• Notes receivable are written promises to pay a specified amount at a future date, often with interest.

• Interest is calculated using the formula: $\text{Interest} = \text{Principal} \times \text{Rate} \times \text{Time}$

Example: A $1,000 note at 6% interest for 6 months earns $30 in interest ($1,000 × 0.06 × 0.5).

Additional Info

• Approximately 2/3 of exam questions are theoretical; the rest are numerical/calculation-based.