Master Financial Accounting: 100 Common Questions Answered

• Financial accounting is primarily concerned with providing information to external users and follows specific rules and regulations (GAAP or IFRS).
• Management accounting provides information to internal users for decision-making and is not subject to the same rules.

The primary objective of financial accounting is to provide relevant, reliable, and comparable financial information to external users.

The key financial statements in financial accounting are:

• Income statement: Shows the organization's revenues, expenses, and net income or loss for a specific period.
• Balance sheet: Shows the organization's assets, liabilities, and equity at a specific point in time.
• Cash flow statement: Shows the organization's cash inflows and outflows from operating, investing, and financing activities.

An income statement summarizes the organization's revenues, expenses, and net income or loss for a specific period. It includes:

• Revenues: Income generated from sales of goods or services.
• Expenses: Costs incurred in generating revenue.
• Net income (or loss): The difference between revenues and expenses.

A balance sheet shows the organization's financial position at a specific point in time. It includes:

• Assets: Resources owned by the organization.
• Liabilities: Obligations owed by the organization.
• Equity: The residual interest in the assets of the organization after deducting liabilities.

A cash flow statement shows the organization's cash inflows and outflows from operating, investing, and financing activities. It helps in understanding the organization's liquidity and ability to generate cash.

• Assets are resources owned by the organization, such as cash, inventory, and equipment.
• Liabilities are obligations owed by the organization, such as accounts payable and loans.

Equity is the residual interest in the assets of the organization after deducting liabilities. It represents the owners' claim on the organization's assets.

Double-entry bookkeeping is a system of recording transactions that ensures that every transaction has an equal and opposite effect on the accounting equation (Assets = Liabilities + Equity). It helps in maintaining accurate financial records and ensuring that the balance sheet balances.

A general ledger is a book of accounts that contains all the accounts used by an organization. It is used to record and summarize transactions.

The accounting equation is: Assets = Liabilities + Equity. It represents the fundamental relationship between an organization's resources, obligations, and owners' claims.

The accounting equation is used to ensure that the balance sheet balances and to analyze the financial position of an organization.

The accrual basis of accounting recognizes revenues when they are earned and expenses when they are incurred, regardless of when cash is received or paid.

The cash basis of accounting recognizes revenues when cash is received and expenses when cash is paid.

Accounts receivable are amounts owed to the organization by customers for goods or services sold on credit.

Accounts payable are amounts owed by the organization to suppliers for goods or services purchased on credit.

A trial balance is a list of all general ledger accounts and their balances at a specific point in time. It is used to verify that the accounting equation is in balance.

Adjusting entries are journal entries made at the end of an accounting period to ensure that revenues and expenses are recorded in the proper period. Examples include adjusting for prepaid expenses, accrued expenses, unearned revenue, and accrued revenue.

Depreciation is the process of allocating the cost of long-term assets over their useful lives. It is a non-cash expense that reduces the value of the asset on the balance sheet.

Depreciation is calculated using a depreciation method such as:

• Straight-line method: Allocates the cost of the asset evenly over its useful life.
• Units-of-production method: Allocates the cost of the asset based on its actual usage.
• Declining-balance method: Allocates a larger portion of the cost of the asset in the early years of its useful life.

Amortization is similar to depreciation but is used for intangible assets, such as patents and copyrights.

Both depreciation and amortization are used to allocate the cost of long-term assets over their useful lives. However, depreciation is used for tangible assets, while amortization is used for intangible assets.

Goodwill is an intangible asset that represents the excess of the purchase price of a business over the fair value of its identifiable net assets.

Prepaid expenses are assets representing payments made in advance for goods or services that will be received in the future.

The matching principle requires that expenses be recognized in the same period as the revenues they help to earn.

The going concern principle assumes that a business will continue to operate for the foreseeable future.

The revenue recognition principle requires that revenue be recognized when it is earned and the performance obligation has been satisfied.

The materiality concept states that only items that are significant enough to affect a user's decision should be disclosed in financial statements.

Contingent liabilities are potential liabilities that depend on the occurrence of future events. They are disclosed in the financial statements if they are probable and can be reasonably estimated.

The historical cost principle requires that assets be recorded at their original cost at the time of acquisition.

A fiscal year is a 12-month period used for accounting purposes. It can be any 12 consecutive months, but it is often chosen to coincide with a natural business cycle.

A fiscal year can be any 12 consecutive months, while a calendar year is always January 1 to December 31.

Financial ratios are calculations that analyze a company's financial performance and position. They can be used to assess profitability, liquidity, solvency, and efficiency.

The current ratio is calculated as: Current assets / Current liabilities. It measures a company's ability to pay its short-term debts.

The quick ratio is calculated as: (Current assets - Inventory) / Current liabilities. It is a more stringent measure of liquidity than the current ratio because it excludes inventory, which can be less liquid.

Working capital is the difference between current assets and current liabilities. It represents the amount of current assets available to cover current liabilities.

The debt-to-equity ratio is calculated as: Total liabilities / Total equity. It measures a company's financial leverage and its ability to meet its long-term debt obligations.

ROA is a measure of profitability that calculates the return on the total assets of a company. It is calculated as (Net income / Total assets) x 100%.

ROE is a measure of profitability that calculates the return on the equity invested in a company. It is calculated as (Net income / Average shareholder's equity) x 100%.

• Gross profit is the difference between sales revenue and the cost of goods sold.
• Net profit is the difference between gross profit and all other operating expenses.

An audit is an independent examination of an organization's financial statements by a qualified professional.

The purpose of an external audit is to provide an independent opinion on the fairness and reliability of an organization's financial statements.

An internal audit is an independent examination of an organization's financial and operational activities conducted by its own employees.

A chart of accounts is a list of all the accounts used by an organization. It is used to organize and classify transactions.

The general journal is a book of original entry where all transactions are recorded.

• Revenue is income generated from sales of goods or services.
• Expenses are costs incurred in generating revenue.

A capital expenditure is an expenditure that benefits the organization over a period of more than one year. Examples include purchases of property, plant, and equipment.

An operating expenditure is an expenditure that benefits the organization in the current period. Examples include salaries, rent, and utilities.

• Short-term liabilities are obligations that are due within one year.
• Long-term liabilities are obligations that are due after one year.

Dividends are payments made to shareholders out of the company's profits.

Retained earnings is the accumulated net income of a company that has not been distributed to shareholders as dividends.

A statement of shareholders' equity shows the changes in the equity section of the balance sheet over a specific period. It includes the beginning balance, net income, dividends, and other equity transactions.

A contra account is an account that has an opposite balance to its related account. For example, accumulated depreciation is a contra asset account that reduces the value of property, plant, and equipment.

Closing entries are journal entries made at the end of an accounting period to transfer temporary accounts (revenue, expense, and dividend accounts) to retained earnings.

A post-closing trial balance is a list of all general ledger accounts and their balances after closing entries have been made. It should show only permanent accounts (assets, liabilities, and equity).

The purpose of financial reporting is to provide relevant, reliable, and comparable financial information to external users.

GAAP is a set of accounting standards that are used in the United States.

IFRS is a set of accounting standards that are used in many countries outside of the United States.

While both GAAP and IFRS have similar objectives, there are some differences in their specific requirements. For example, IFRS generally requires more detailed disclosures than GAAP.

Fair value accounting is a method of valuing assets and liabilities at their current market value, rather than at their historical cost. It is used for certain types of assets, such as investments and derivatives.

• Capital reserves are created from transactions that do not affect the organization's profit or loss, such as share premiums or revaluation surpluses.
• Revenue reserves are created from the accumulation of profits that have not been distributed to shareholders.

Intangible assets are assets that do not have a physical substance, such as patents, trademarks, and goodwill.

Tangible assets are assets that have a physical substance, such as property, plant, and equipment.

Inventory is a current asset that represents goods held for sale, in production, or for use in the production process.

The FIFO (First-In, First-Out) method assumes that the first units purchased are the first units sold. This method tends to result in higher net income in times of rising prices.

The LIFO (Last-In, First-Out) method assumes that the last units purchased are the first units sold. This method tends to result in lower net income in times of rising prices.

The weighted average cost method calculates the average cost of all units available for sale and assigns this cost to each unit sold.

COGS is the cost of inventory sold during a period. It is calculated as the beginning inventory plus purchases minus ending inventory.

Gross profit is calculated as: Sales revenue - Cost of goods sold.

Deferred revenue is a liability that represents revenue that has been received in advance but has not yet been earned.

Deferred expense is an asset that represents an expense that has been paid in advance but has not yet been incurred.

Accruals are adjusting entries that recognize expenses or revenues that have been incurred or earned but have not yet been paid or received.

Impairment loss is a loss recognized when the carrying value of an asset exceeds its recoverable amount.

• Current assets are assets that are expected to be realized, sold, or consumed within one year.
• Non-current assets are assets that are expected to be held for more than one year.

Goodwill impairment occurs when the carrying value of goodwill exceeds its recoverable amount.

A provision is a liability that represents a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources.

Financial liabilities are obligations to transfer economic resources to other entities as a result of past transactions.

Revenue is the income generated from the sale of goods or services.

• Operating revenue is revenue generated from the primary activities of the business.
• Non-operating revenue is revenue generated from other sources, such as interest income or gains on the sale of investments.

The debt-to-assets ratio is calculated as: Total liabilities / Total assets. It measures a company's financial leverage and its ability to meet its long-term debt obligations.

Horizontal analysis compares financial data from different periods to identify trends and changes. It is often presented as a percentage increase or decrease.

Vertical analysis expresses each item on a financial statement as a percentage of a base amount, such as total assets for the balance sheet or total revenue for the income statement.

• Liquidity refers to a company's ability to meet its short-term obligations.
• Solvency refers to a company's ability to meet its long-term obligations.

Shareholder equity is the residual interest in the assets of the organization after deducting liabilities. It represents the owners' claim on the organization's assets.

EPS is a measure of profitability that calculates the earnings attributable to each common share. It is calculated as (Net income - Preferred dividends) / Weighted average number of common shares outstanding.

Book value per share is the value of a company's common stock based on its book value. It is calculated as (Total shareholder equity / Number of common shares outstanding).

• Book value is the value of an asset based on its recorded cost minus accumulated depreciation.
• Market value is the price at which an asset can be sold in the current market.

Extraordinary items are unusual and infrequent events that are not expected to recur. Examples include natural disasters or legal settlements.

Contingent assets are potential assets that depend on the occurrence of future events. They are not recognized in the financial statements unless they are probable and can be reliably measured.

Deferred tax liabilities are potential tax liabilities that arise from temporary differences between the tax basis of assets and liabilities and their carrying values in the financial statements.

Financial leverage is the use of debt financing to increase the return on equity. A high degree of financial leverage can amplify both profits and losses.

• Capital leases are leases that transfer ownership of the leased asset to the lessee at the end of the lease term. They are recorded as assets and liabilities on the balance sheet.
• Operating leases are leases that do not transfer ownership of the leased asset. They are recorded as operating expenses on the income statement.

Stockholders' equity is the residual interest in the assets of the organization after deducting liabilities. It represents the owners' claim on the organization's assets.

A bond is a debt security issued by a corporation or government entity to raise capital. It represents a promise to pay interest and principal to bondholders.

Amortized cost is the cost of a bond adjusted for any premium or discount over its life.

Cash equivalents are short-term, highly liquid investments that can be readily converted to cash.

The steps in the accounting cycle are:

1. Journalize transactions: Record transactions in the general journal.
2. Post to the general ledger: Transfer journal entries to the general ledger.
3. Prepare a trial balance: Verify that the accounting equation is in balance.
4. Make adjusting entries: Adjust accounts for accruals, deferrals, and depreciation.
5. Prepare an adjusted trial balance: Verify that the accounting equation is in balance after adjusting entries.
6. Prepare financial statements: Prepare the income statement, balance sheet, and cash flow statement.
7. Close the books: Transfer temporary accounts to retained earnings.
8. Prepare a post-closing trial balance: Verify that only permanent accounts have balances.

• Single-step income statements group all revenues together and all expenses together.
• Multi-step income statements present revenues and expenses in a more detailed format, separating operating and non-operating items.

A comprehensive income statement reports all changes in equity during a period, including net income and other comprehensive income items, such as foreign currency translation adjustments and unrealized gains or losses on certain investments.