Completion of Accounting Chapter Summaries

ACC 201: Essentials of Accounting

Your Name: _ Please write extra notes in red Ink.

Chapter 12: How do firms Keep Track of their Transactions?

1. What is the Difference between GAAP and IFRS?

· GAAP stands for Generally Accepted Accounting Principles that US companies must follow in preparing their financial statements to make them believable and comparable.

· IFRS stands for International Financial Reporting Standards that more and more companies are following (in addition to their local financial reporting standards) to make comparisons with companies around the world easier.

2. What is a Double Entry?

· According to GAAP and IFRS, at any point in time the source of funds must balance with the use of funds of an organization.

The essence of these rules

· Liabilities (current plus long-term) and Owner’s Equity (contributed capital plus retained earnings) make up the source of funds. Assets (current plus long-term) make up the use of funds.

There are liabilities and loans

· Every transaction calls for a ‘double entry’ (change in at least two of the above accounts) in such a way that the source of funds remains balanced with the use of funds.

if you change one entry, the source of funds will not balance, must keep it balanced!

· Examples:

1. Owners investing $3,200 increases Contributed Capital and cash.

2. Purchasing equipment for $1,500 decreases cash and increases LT Assets.

3. Spending $1700 on initial expenses decreases cash and Retained Earnings.

1 2 3 Total

Use of funds:

Cash: + 3200 - 1500 - 1700 0

Other current assets: 0

Long-term assets: + 1500 1500

Total assets: 1500

Source of funds :

Current Liabilities: 0

Long-term Liabilities: 0

Contributed Capital: + 3200 3200

Retained earnings: - 1700 - 1700

Total Liabilities plus Owner’s Equity: __15003

3. What are Debits and Credits?

What is a double entry???

Decrease cash!

· Credit can be viewed a good news and debit a bad news with respect to funds in an organization.

· Accordingly, increase in funds through liabilities or owner’s equity is considered a credit and decrease in funds through the investment in an asset is considered a debit.

· As such revenues (which increases retained earnings) is also considered a credit.

· Similarly, decrease in source of funds (liabilities /equity is considered a debit and in LT assets (through sale) is considered a credit.

· As such, expenses or dividends (which decreases retained earnings) is also considered a debit.

· But one need NOT remember the debit/credit conventions (or about T accounts, journal entries, and trial balances) if he or she can understand transaction analysis - the impact of transactions on assets, liabilities, equity, revenues, expenses and dividends.

4. What are some Important Principles that Govern the Double Entry?

· Conservatism Principle: When in doubt, be conservative in valuing assets and reporting earnings.

· When in doubt be conservative

· Accrual Accounting: An accounting method that measures the economic income of a company by recognizing economic events regardless of when cash transactions occur.

· Revenue Recognition Principle: Recognize revenues only after earning it, irrespective of when you collect the cash.

· Matching Principle: Match all costs incurred to bring about revenues as expenses irrespective of when you pay for it. This is why it is important to recognize as expenses even the use of owner’s time and resources.

· Objectivity Principle: When valuing expenses and assets use objective and verifiable numbers as much as possible.

5. Why following these Principles Require Some Adjusting Entries at the End of a Period?

· During the period some revenues may have been earned and expenses incurred without any immediate cash implications.

· The lack of cash implications causes firms to forget to recognize these economic events in a timely manner.

· Also, it is more convenient to delay the recognizing of reuccring _ expenses to the end of the period.

· This is why adjusting entries are made just before preparing_ the financial statements of a period.

6. What are the major transactions during the start-up phase?

· Financing activities: _______________________________________________________________

· Investment activities that are capitalized or expensed: _____________________________________

7. What are the major transactions during each year (operating cycle)?

· Production activities

· Selling activities

· Distribution activities

· Cash collection activities

· Servicing activities

· Administrative activities

· Interest related activities

8. What is the Connection Between Transaction Analysis and the Balance Sheet?

· A Balance Sheet essentially reports the _ending__ balances in each of the accounts in the transaction analysis.

· If the transaction analysis was done right, the source of funds must balance with the use of funds after each transaction.

9. Which Balance Sheet Items receive the Most Entries During Transaction Analysis?

· Given the many transactions that relate to cash receipts_ and expenditures_, the cash account tends to receive the most entries during the transaction analysis.

· Given the many economically significant events that relate to the performance of a company, the retained earnings account tends to receive the second most entries during the transaction analysis.

10. How Does Transaction Analysis Connect with the Cash Flow And Income Statements?

· Given outsider’s interest in predicting future profitability, both GAAP and IFRS require that firms summarize the many entries made in the cash and retained earnings accounts and report them separately as cash flow and ____income___ statements.

· Furthermore, GAAP and IFRS require that cash flows from operations, investments and financing be reported separately in the cash flow statement.

· Similarly, they require that revenues_ and _______________ be reported separately in the income statement.