Financial Accounting Management Flashcards

Question 1

What is the main purpose of financial accounting?

Accepted Answer

Financial accounting records and summarizes a business's transactions so that outsiders, such as investors, creditors, and regulators, can judge its financial position and performance. It follows common rules, called generally accepted accounting principles in the United States, so reports stay consistent and comparable across organizations and time periods. Its focus is external reporting rather than internal decision making.

Question 2

What does the business entity assumption require accountants to do?

Accepted Answer

The business entity assumption requires that a business's financial records be kept separate from the personal records of its owners and from those of any other organization. Each separate entity keeps its own set of books and prepares its own financial reports.

Question 3

What is the going concern assumption in accounting?

Accepted Answer

The going concern assumption presumes that a business will continue operating long enough to use its assets and meet its obligations in the normal course of activity. Because of this assumption, assets such as equipment are recorded at cost and depreciated over their useful lives rather than valued at liquidation prices. If there is real doubt about continuing, that uncertainty must be disclosed to financial statement users.

Question 4

What are the two fundamental qualitative characteristics of useful financial information?

Accepted Answer

The two fundamental qualitative characteristics of useful financial information are relevance and faithful representation. Relevant information can make a difference in the decisions of users, often because it has predictive or confirmatory value. Faithful representation means the information is complete, neutral, and free from material error.

Question 5

What does the cost principle require for recording most assets?

Accepted Answer

The cost principle requires that most assets be recorded at their original purchase price, including costs needed to get the asset ready for use, rather than at their current market value. This makes records objective and verifiable because the purchase price is supported by a transaction.

Question 6

What does the monetary unit assumption mean for accounting records?

Accepted Answer

The monetary unit assumption means that accounting records only measure items that can be expressed in a stable currency, such as US dollars. Non-monetary matters, like employee morale or a company's reputation, are not recorded even if they matter to the business.

Question 7

What does the materiality concept mean in financial reporting?

Accepted Answer

The materiality concept means that an item matters for reporting when leaving it out or misstating it could change the decisions of people relying on the statements. Materiality involves judgment, and it depends on both the size and the nature of an item. Small amounts that would not influence those decisions can be expensed immediately rather than capitalized.

Question 8

Why is the matching principle important for recording expenses?

Accepted Answer

The matching principle requires that expenses be recorded in the same period as the revenues they helped produce. This gives a truer picture of each period's profit. For example, the cost of goods sold is recognized when the goods are sold, not when they were bought.

Question 9

What is the basic accounting equation that every business uses?

Accepted Answer

The basic accounting equation states that assets equal liabilities plus owner's equity. Assets are resources the business controls, liabilities are obligations to outside parties, and equity is the owners' residual claim after liabilities are subtracted. Every transaction must keep this equation in balance.

Question 10

What does double-entry bookkeeping require for each transaction?

Accepted Answer

Double-entry bookkeeping requires that every transaction be recorded in at least two accounts, with total debits equal to total credits. This structure creates a built-in check, because an error that throws the books out of balance is easier to detect. Each entry shows both where value came from and where it went.

Question 11

How do debits and credits affect asset and expense accounts?

Accepted Answer

Debits increase asset and expense accounts, while credits decrease them. Liability, equity, and revenue accounts work in the opposite way, so credits increase them and debits decrease them. Remembering this pattern is easier when you learn the normal balance of each account type.

Question 12

What is a journal entry and what does it contain?

Accepted Answer

A journal entry is the first formal record of a business transaction, made in chronological order in the general journal. Each entry includes the date, the accounts affected, the debit and credit amounts, and a short description of the event. Entries are later posted to the ledger, where each account's balance is tracked.

Question 13

What is the difference between the general journal and the general ledger?

Accepted Answer

The general journal is the chronological record where transactions are first entered, showing each event as a complete entry. The general ledger is the collection of accounts that organizes those entries by account, so a person can see the running balance of cash, payables, or sales.

Question 14

What is a trial balance and what is its main purpose?

Accepted Answer

A trial balance lists all ledger accounts and their balances at a point in time. Its main purpose is to confirm that total debits equal total credits, which signals that postings were made without arithmetic errors. A balanced trial balance does not guarantee correct entries, since posting to the wrong account still leaves totals equal.

Question 15

What is a contra account, and give one example?

Accepted Answer

A contra account is an account that carries a balance opposite to the account it offsets, reducing that account's reported amount. For example, accumulated depreciation is a contra asset account that is subtracted from equipment cost on the balance sheet. Allowance for doubtful accounts is another common example.

Question 16

What is the purpose of an adjusting entry at period end?

Accepted Answer

An adjusting entry updates account balances at the end of an accounting period so that revenues and expenses are recorded in the correct period. It is needed because some transactions span multiple periods, such as prepaid rent or wages earned but not yet paid.

Question 17

Which four financial statements make up a complete set of general purpose financial statements?

Accepted Answer

A complete set of financial statements usually includes the balance sheet, the income statement, the statement of cash flows, and the statement of changes in equity. The balance sheet shows financial position at one date, while the other three cover activity over a period. Notes to the statements explain the policies used.

Question 18

What information does a balance sheet present, and when?

Accepted Answer

A balance sheet presents a company's assets, liabilities, and equity as of a specific date. Current assets and current liabilities are listed separately, usually in order of how quickly they will be converted to cash or settled. The totals must satisfy the basic accounting equation.

Question 19

What does the income statement report, and over what time frame?

Accepted Answer

The income statement reports revenues, expenses, and resulting net income or net loss over a period such as a month, quarter, or year. Its bottom line shows whether the business was profitable during that span. Unlike the balance sheet, it does not show a single point in time.

Question 20

Why does the statement of cash flows matter even when a company reports profit?

Accepted Answer

The statement of cash flows matters because net income is calculated on an accrual basis and can differ from actual cash generated. A profitable company can still struggle to pay bills if customers have not yet paid or inventory is piling up. The statement groups cash movements into operating, investing, and financing activities.

Question 21

What are the three main sections of the statement of cash flows?

Accepted Answer

The three main sections are operating activities, investing activities, and financing activities. Operating activities cover cash from core business operations such as sales and paying suppliers. Investing activities cover buying or selling long-term assets, and financing activities cover borrowing, repaying debt, and transactions with owners.

Question 22

What is the basic formula for net income on the income statement?

Accepted Answer

Net income equals total revenues minus total expenses for the period. If expenses exceed revenues, the result is a net loss instead. Gains and losses from outside the normal operations are often shown separately, and taxes are subtracted to reach the final figure.

Question 23

What does the statement of changes in equity show?

Accepted Answer

The statement of changes in equity shows how each component of owners' equity moved during the period. Common movements include net income or loss, owner contributions, dividends or withdrawals, and any other comprehensive income. It explains the bridge between opening and closing equity balances on the balance sheet.

Question 24

How do the balance sheet and income statement connect through retained earnings?

Accepted Answer

Net income from the income statement increases retained earnings on the balance sheet, while dividends paid to shareholders decrease it. Retained earnings is the cumulative profit a company has kept rather than distributed. This link shows that the two statements describe the same underlying activity from different angles.

Question 25

What is the accrual basis of accounting, compared with cash basis?

Accepted Answer

Accrual basis accounting records revenues when they are earned and expenses when they are incurred, regardless of when cash changes hands. Cash basis accounting, by contrast, records transactions only when cash is received or paid. Accrual accounting gives a more complete view of performance over time.

Question 26

What must usually happen before a company recognizes revenue from a sale?

Accepted Answer

Revenue is usually recognized when the company has satisfied its performance obligation by transferring promised goods or services to the customer. The customer gains control of the item or benefit, and the amount the company expects to receive can be reasonably measured. Collection of cash does not have to happen first.

Question 27

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

Accepted Answer

An accrued expense is a cost the business has incurred but not yet paid, such as wages earned by employees at the end of a period. It is recorded with an adjusting entry that debits the expense account and credits a liability, often accrued wages payable. Later, the payment reduces that liability.

Question 28

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

Accepted Answer

A prepaid expense is cash paid in advance for a benefit that will be used later, such as twelve months of insurance. It is first recorded as an asset. As the benefit is used up, an adjusting entry moves the used portion from the asset to an expense account.

Question 29

What is depreciation, and why is it recorded?

Accepted Answer

Depreciation is the systematic allocation of the cost of a tangible long-lived asset over its useful life. It matches part of the asset's cost to the revenues it helps generate each period. Depreciation is not a measure of market value, and it does not create a cash fund for replacing the asset.

Question 30

What is the allowance method for uncollectible accounts?

Accepted Answer

The allowance method estimates uncollectible accounts receivable in the period of the related sales. The estimate is recorded as bad debt expense and as a contra asset called allowance for doubtful accounts. When a particular account is later written off, it is removed against the allowance, leaving net receivables unchanged.

Question 31

How does the accrual adjustment for unearned revenue work?

Accepted Answer

Unearned revenue is cash received before goods or services are delivered, so it is initially recorded as a liability. As the company performs the work, an adjusting entry debits unearned revenue and credits revenue for the portion earned. For example, a twelve-month subscription paid in advance is earned gradually over that year.

Question 32

What is a sales returns and allowances account used for?

Accepted Answer

The sales returns and allowances account is a contra revenue account that tracks reductions in sales caused by customer returns or price concessions for defective goods. Recording returns separately gives managers information about product quality and return rates. Net sales is reported as gross sales minus this account.

Question 33

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

Accepted Answer

The current ratio equals current assets divided by current liabilities. It measures a company's ability to pay obligations due within one year using assets expected to become cash within that same period. A ratio above one suggests current assets exceed current liabilities, though what counts as adequate depends on the industry.

Question 34

What does the quick ratio measure that the current ratio does not?

Accepted Answer

The quick ratio, also called the acid-test ratio, excludes inventory and prepaid expenses from current assets because they may be hard to convert to cash quickly. It equals cash, marketable securities, and receivables divided by current liabilities. This gives a stricter view of short-term liquidity, especially for businesses whose inventory moves slowly.

Question 35

How is gross profit margin calculated, and what does it show?

Accepted Answer

Gross profit margin equals gross profit divided by net sales, usually expressed as a percentage. Gross profit is net sales minus cost of goods sold. The result shows how much of each sales dollar remains after paying for the goods or services sold, before operating expenses such as rent and salaries.

Question 36

What does the debt-to-equity ratio tell a reader about a company?

Accepted Answer

The debt-to-equity ratio compares total liabilities with shareholders' equity, indicating how much of the business is financed by creditors relative to owners. A higher ratio means greater reliance on borrowing, which can raise financial risk because interest and principal must be paid regardless of profit. Acceptable levels vary widely by industry.

Question 37

What is return on equity, and what is its basic formula?

Accepted Answer

Return on equity measures how much net income a company generates for each dollar of shareholders' equity. The basic formula divides net income for the period by average or ending shareholders' equity. A high return can reflect strong profitability, but it can also be inflated by heavy borrowing, so pair it with leverage measures.

Question 38

What is the inventory turnover ratio and why does it matter?

Accepted Answer

Inventory turnover equals cost of goods sold divided by average inventory, showing how many times inventory is sold and replaced during a period. A higher turnover generally suggests efficient inventory management and strong demand, while a low turnover may point to slow sales or obsolete stock.

Question 39

Why do analysts compare ratios over time and against competitors?

Accepted Answer

Analysts compare ratios over time and against peers because a single ratio has little meaning on its own. A trend across several periods shows whether performance is improving or deteriorating. Comparison with competitors or industry averages provides context, since normal levels differ between industries such as grocery retail and software.

Question 40

What does the earnings per share figure represent for common shareholders?

Accepted Answer

Earnings per share equals net income available to common shareholders divided by the weighted average number of common shares outstanding. It shows the profit attributable to each common share. Preferred dividends are subtracted first when they exist, because preferred holders have a prior claim on earnings.

Financial Accounting Management Flashcards

1Foundations of Financial Accounting

2Accounting Equation and Double-Entry Recording

3Core Financial Statements

4Revenue, Expenses and Accrual Adjustments

5Financial Analysis and Ratios

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