Financial Accounting Basics Flashcards

Question 1

What is the basic accounting equation, and what does each term represent?

Accepted Answer

The accounting equation states that assets equal liabilities plus owner's equity. Assets are resources the business controls that are expected to provide future benefit, such as cash and equipment. Liabilities are obligations owed to outside parties, such as loans. Owner's equity is the residual interest left after liabilities are subtracted from assets.

Question 2

What is the business entity concept in financial accounting?

Accepted Answer

The business entity concept states that a business's financial records must be kept separate from the personal finances of its owners and from any other organization. Transactions are recorded from the viewpoint of the business itself. This separation lets readers evaluate the company's performance without mixing in the owner's personal spending or savings.

Question 3

What does the going concern assumption tell accountants to presume?

Accepted Answer

The going concern assumption presumes that a business will continue operating long enough to carry out its current plans and obligations. Because of this, assets are generally recorded at cost rather than at liquidation value, and long-lived assets are depreciated over their useful lives.

Question 4

What is the monetary unit assumption and why does it matter?

Accepted Answer

The monetary unit assumption holds that only transactions measurable in a stable currency are recorded in the accounting records. Financial statements therefore report amounts in a single currency, such as dollars, which makes different items comparable. Non-monetary factors like employee morale or brand reputation are not recorded, even though they may affect future results.

Question 5

What is the historical cost principle, and how does it apply to asset values?

Accepted Answer

The historical cost principle requires assets and liabilities to be recorded at the amount paid or received when they were first acquired. This original amount is generally kept on the books even if market values change later. Historical cost is reliable and verifiable, though it may not show what an asset is currently worth.

Question 6

What is the time period assumption, and why do companies report in periods?

Accepted Answer

The time period assumption states that an organization's economic life can be divided into artificial time intervals, such as months, quarters, and years, for reporting purposes. Companies report in periods so that users receive timely information for decisions rather than waiting until the business closes. Each period's results are summarized separately.

Question 7

Who are the primary users of general purpose financial statements?

Accepted Answer

The primary users are existing and potential investors, lenders, and other creditors, who need information to make decisions about providing resources to an entity. Management and regulators also rely on these reports, but they often have access to additional internal information. Financial statements are designed mainly for outside parties who cannot demand detailed records.

Question 8

What is materiality, and how does it influence accounting decisions?

Accepted Answer

Materiality is the idea that information matters when omitting or misstating it could reasonably change the decisions of people relying on the financial statements. Small amounts that would not affect those decisions may be treated in a simpler way. Judging materiality requires professional judgment about both the size and nature of an item.

Question 9

What is double-entry bookkeeping, and why is it used?

Accepted Answer

Double-entry bookkeeping records every transaction in at least two accounts, with total debits always equal to total credits. Each transaction therefore has a dual effect that keeps the accounting equation in balance. This method creates a built-in check that helps catch errors and keeps the books in balance.

Question 10

What is the difference between a debit and a credit?

Accepted Answer

A debit is the left side of an account entry and a credit is the right side. Debits increase asset and expense accounts, while credits increase liability, equity, and revenue accounts. The words themselves carry no good or bad meaning; they simply indicate which side of the account is affected.

Question 11

What is a normal balance, and how is it determined for each account?

Accepted Answer

A normal balance is the side, debit or credit, on which an account carries its balance, which is the side that increases the account. Asset and expense accounts normally have debit balances, while liability, equity, and revenue accounts normally have credit balances. Knowing these defaults helps you spot entries that appear to be backward.

Question 12

What is a journal entry and what information does it contain?

Accepted Answer

A journal entry is the first formal record of a transaction, made in chronological order in the journal. Each entry includes the date, the accounts affected, the debit and credit amounts, and a brief explanation. Journal entries provide an audit trail, so anyone reviewing the records can trace each balance back to its source.

Question 13

What is the general ledger, and how does it relate to the journal?

Accepted Answer

The general ledger is the collection of all accounts a business uses, with a running balance for each account. Information moves from the journal to the ledger through posting, which transfers each journal amount to its account. The journal records transactions in time order, while the ledger organizes them by account.

Question 14

What is a chart of accounts and why do businesses maintain one?

Accepted Answer

A chart of accounts is an organized list of every account a business uses, each with a unique number and name. Accounts are grouped by category, such as assets, liabilities, equity, revenue, and expenses, so related transactions are recorded consistently. A clear chart makes it easier to prepare reports and train staff.

Question 15

What is a trial balance, and what does it verify?

Accepted Answer

A trial balance is a list of all ledger account balances, with debits and credits in separate columns. It verifies that total debits equal total credits, which confirms the arithmetic of the double-entry process. A trial balance cannot catch every error, because posting to the wrong account still leaves totals equal.

Question 16

What does it mean when a trial balance does not balance?

Accepted Answer

When a trial balance does not balance, total debits and total credits differ, which signals that at least one error exists in the recording or posting process. Common causes include a transposed amount or an entry posted to the wrong side. Reviewing recent entries is a sound first step.

Question 17

What is the income statement, and what does it report?

Accepted Answer

The income statement reports a company's revenues, expenses, gains, and losses over a specific period, and it ends with net income or net loss. It shows how profitable the business was during that time. Because it covers a period rather than a single moment, it is described as a summary of activity.

Question 18

What is the balance sheet, and why is it sometimes called the statement of financial position?

Accepted Answer

The balance sheet lists a company's assets, liabilities, and equity at one specific date. It is called the statement of financial position because it presents the company's financial condition at that point in time. The two sides must always balance, since total assets equal total liabilities plus equity.

Question 19

What is the statement of cash flows, and what are its three main sections?

Accepted Answer

The statement of cash flows explains how cash moved into and out of a business during a period. Its three main sections are operating activities, which relate to day-to-day operations, investing activities, which cover buying and selling long-term assets, and financing activities, which involve borrowing, repaying debt, and transactions with owners.

Question 20

What is the statement of owner's equity, and what changes does it show?

Accepted Answer

The statement of owner's equity, sometimes called the statement of changes in equity, shows how the owner's capital changed during a period. Beginning equity is adjusted for net income or net loss, owner contributions, and owner withdrawals to arrive at ending equity. This ending figure then appears on the balance sheet.

Question 21

How are the income statement and the balance sheet linked together?

Accepted Answer

Net income from the income statement flows into retained earnings or owner's capital, which is part of equity on the balance sheet. This is why each period's profit changes the balance sheet. The income statement explains the change in equity, while the balance sheet shows the resulting position.

Question 22

What is gross profit, and how is it calculated?

Accepted Answer

Gross profit is the amount left after subtracting cost of goods sold from net sales revenue. It shows how much a business earns from its core product or service before paying operating expenses such as rent, salaries, and utilities. Gross profit is a useful measure of pricing and production efficiency.

Question 23

What is net income, and how does it differ from gross profit?

Accepted Answer

Net income is the bottom line of the income statement, calculated by subtracting all expenses, including operating costs, interest, and income taxes, from total revenues and gains. Gross profit is only an intermediate subtotal that ignores operating expenses and other items below the gross profit line. Net income reflects the full result.

Question 24

What order are the financial statements typically prepared in, and why?

Accepted Answer

Statements are typically prepared in this order: income statement, statement of owner's equity, balance sheet, and then statement of cash flows. Each uses figures from the previous step, so the income statement feeds equity and equity feeds the balance sheet. The cash flow statement is completed last because it draws on the other statements.

Question 25

What is the difference between cash basis and accrual basis accounting?

Accepted Answer

Cash basis accounting records revenue when cash is received and expenses when cash is paid. Accrual basis accounting records revenue when it is earned and expenses when they are incurred, regardless of when cash changes hands. Accrual accounting gives a complete picture of performance, which is why it is the usual basis for financial reporting.

Question 26

What does the revenue recognition principle require accountants to do?

Accepted Answer

The revenue recognition principle requires revenue to be recorded when it is earned, which generally means when goods or services have been delivered to the customer. The amount recorded should reflect what the business expects to receive in exchange. Recording revenue at delivery keeps results tied to actual performance.

Question 27

What is the matching principle, and why does it matter?

Accepted Answer

The matching principle requires expenses to be recorded in the same period as the revenues they helped produce. This allows the income statement to show a meaningful relationship between effort and results. Without matching, a company that prepaid a large commission could appear unprofitable in one period and highly profitable in the next.

Question 28

What is an accrued expense, and how is it recorded?

Accepted Answer

An accrued expense is a cost that has been incurred during a period but not yet paid or billed by period end. To record it, the accountant debits an expense account and credits a liability, such as accrued wages payable. The liability is settled when the cash is actually paid later.

Question 29

What is unearned revenue, and how does it become earned?

Accepted Answer

Unearned revenue is cash received from a customer before the business has delivered the goods or services, so it is recorded as a liability. As the business performs the obligation, an adjusting entry debits unearned revenue and credits a revenue account. The liability shrinks and revenue grows as the work is completed.

Question 30

What is an adjusting entry, and when is it made?

Accepted Answer

An adjusting entry updates balances at the end of an accounting period so that revenues and expenses appear in the period they belong to. Adjusting entries are needed for items such as accrued expenses, unearned revenue, prepaid expenses, and depreciation. They usually do not involve cash, because cash transactions are recorded when they occur.

Question 31

How is depreciation recorded in an adjusting entry?

Accepted Answer

Depreciation is recorded by debiting depreciation expense and crediting accumulated depreciation, a contra asset account. This spreads the cost of a long-lived asset, such as equipment, over its useful life. The asset's original cost stays unchanged on the books, while accumulated depreciation grows each period.

Question 32

What is a prepaid expense, and how is it adjusted over time?

Accepted Answer

A prepaid expense is a payment made in advance for goods or services not yet used, such as insurance or rent paid for future months. It is initially recorded as an asset. As the benefit is used up, an adjusting entry debits an expense account and credits the prepaid asset account, reducing it.

Question 33

What is allowance for doubtful accounts, and why is it used?

Accepted Answer

The allowance for doubtful accounts is a contra asset account that estimates the portion of accounts receivable a business does not expect to collect. It is used to present receivables at their expected collectible amount, called net realizable value. Recording the estimate in the same period as related credit sales follows the matching principle.

Question 34

How does a bank reconciliation help a business?

Accepted Answer

A bank reconciliation compares the cash balance in the company's records with the balance reported on the bank statement and explains any differences. Differences often come from timing, such as deposits in transit and outstanding checks, or from items like bank fees. Completing it helps detect errors and fraud and confirms the cash balance.

Question 35

What is the difference between accounts payable and notes payable?

Accepted Answer

Accounts payable are short-term obligations to suppliers for goods or services bought on credit, usually without interest and without a signed promissory note. Notes payable are written promises to pay a specified amount, often with interest and a set due date. Both are liabilities, but notes payable are more formal and can be long term.

Question 36

What is a current liability, and how does it differ from a noncurrent liability?

Accepted Answer

A current liability is an obligation expected to be settled within one year or the operating cycle, whichever is longer. A noncurrent liability is due after that point, such as a mortgage or bonds payable with a long maturity. The distinction matters because current liabilities are compared with current assets to judge short-term liquidity.

Question 37

What does the current ratio measure, and how is it calculated?

Accepted Answer

The current ratio measures a company's ability to pay its short-term obligations with its short-term assets. It is calculated by dividing total current assets by total current liabilities. A ratio above one suggests current assets exceed current liabilities, though the appropriate level varies by industry.

Question 38

What is accumulated depreciation, and where does it appear on the balance sheet?

Accepted Answer

Accumulated depreciation is the total depreciation recorded against an asset since it was acquired. It appears as a contra asset, listed directly beneath the related asset's cost and subtracted from it. The difference is the asset's book value, also called carrying amount, which shows the portion of cost not yet expensed.

Question 39

How does the first in, first out method value inventory?

Accepted Answer

The first in, first out method assumes the oldest inventory items are sold first, so ending inventory is valued at the most recent costs. Cost of goods sold is based on the earliest costs. During periods of rising prices, this method typically produces higher reported net income than the last in, first out method.

Question 40

What is a petty cash fund, and how is it replenished?

Accepted Answer

A petty cash fund is a small amount of cash kept on hand for minor expenses. When the fund runs low, a check is written for the receipts total, cash is withdrawn, and the fund is restored. Replenishing it debits the expense accounts shown on the receipts and credits cash.

Financial Accounting Basics Flashcards

1Core Accounting Concepts

2Recording Transactions

3Financial Statements Explained

4Accrual Accounting and Adjustments

5Assets and Liabilities in Practice

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