Financial Accounting Key Concepts and Formulas

Chapter 1: Financial Act – Key Concepts

Financial Act: External users making decisions.

Relevance: Predictive, confirmatory, material.

Faithful Representation: Completeness, neutrality, free of error.

Enhancing Qualitative Characteristics: Comparability, verifiability (can you trace balance), timeliness, understandability (clear and concise).

Assumptions: Economic entity (separates unit from owners), going concern (continuing operations), monetary unit (no inflation), periodicity (history of financial periods).

Revenue: When earned.

Expense: When incurred/occurs.

Full Disclosure: All information needed.

Chapter 2: Debits and Credits & Account Types

Debit (Dr): Expenses, Assets, Dividends.

Credit (Cr): Liabilities, Stock, Revenue, Retained Earnings (RE).

Assets: Cash, Accounts Receivable (A/R), Prepaid Expenses, Prepaid Insurance, Supplies, Inventory, Equipment, Building, Intangible Assets.

Liabilities: Accounts Payable (A/P), Accrued Expenses, Notes Payable (N/P), Deferred Revenue.

“On Account”: A/P or A/R.

Chapter 3: Financial Statement Presentation

Multistep: More level 4 analysis (presentation).

Operating: Sales, Cost of Goods Sold (COGS), Selling, General/Administrative Expenses.

Non-Operating: Dividend Revenue, Gain/Loss on Sales of Assets, Interest Revenue/Expense.

Change in Estimate: Prospective. Principle: Retrospective. Error Correction: Restate Financials.

Chapter 4: Balance Sheet Components

Current Assets (CA): Cash, Cash Equivalents, Restricted Cash, Short-Term Investments, A/R, Notes Receivable (N/R), Inventory, Prepaid Expenses.

Long-Term Assets (LTA): Long-Term Investments, Intangible Assets, Equipment.

Current Liabilities (CL): A/P, Short-Term Notes, Deferred Revenue, Accrued Liabilities.

Long-Term Liabilities (LL): Long-Term Debt, Operating Leases.

Working Capital (WC): CA – CL.

10K: Annual Financial Statements (Management’s Discussion and Analysis (MDA), Financials, Auditor’s Opinion).

10Q: Quarterly Financial Statements.

8K: Significant Events.

Chapter 5: Cash Flow Statement Categories

Operating Activities: Current Assets and Current Liabilities.

Investing Activities: Long-Term Assets.

Financing Activities: Long-Term Liabilities and Equity.

Days in A/R: 365 / Receivables Turnover.

A/R Turnover (Collection): Net Sales / Average A/R.

Inventory Turnover: COGS / Average Inventory.

Asset Turnover: Sales / Average Total Assets.

Fixed Asset Turnover: Sales / Average Fixed Assets.

Chapter 7: Revenue Recognition

Revenue Recognition Steps:

  1. Identify contracts (approved, payment terms, collection probable, obligations are defined, commercial substance).
  2. Identify performance obligations.
  3. Determine transaction price.
  4. Allocate transaction price to performance obligations.
  5. Recognize revenue when (or as) each performance obligation is satisfied.

Principal: Provides goods/services.

Agent: Arranges for sales & earns commission.

Consideration Payable: Selling Price – Consideration Payable (credits, discounts, rebates) = Transaction Price.

Expected Value Method: Amount * % of possibility = Revenue recognized -> add up all possibilities.

Chapter 8: Cash and Cash Equivalents

Cash should be converted within 3 months.

Cash: Currency, money orders, cashier’s checks.

Cash Equivalents: Short-Term Treasury Bills, Certificates of Deposit (CDs), Money Market Funds, Short-Term Notes.

Bank Balance: Bank Balance + Deposits in Transit – Outstanding Checks +/- Bank Errors.

Book Balance: +Notes Collected + Interest Received – Service Charge – NSF Checks – Electronic Funds Transfers (EFTs) +/- Book Errors.

Chapter 9: Inventory Costing Methods

Periodic Inventory System: COGS only calculated at the end of the period.

Perpetual Inventory System: Ongoing allocation of COGS.

Net Purchases: Purchases + Freight In – Returns or Discounts.

FIFO (First-In, First-Out): Lower COGS, higher Net Income (NI), higher Ending Inventory.

Average Cost Method: (Total Cost of Goods Available for Sale) / (Total Units Available for Sale)

Chapter 10: Inventory Valuation

Net Realizable Value (NRV) > Cost = No entry.

NRV < Cost = Decrease Inventory -> Dr. COGS, Cr. Inventory.

Put in order & pick the middle # then always pick lowest #.

NRV = Selling Price – Cost of Disposal.

Floor = NRV – Normal Profit Margin (PM).

Gross Profit (GP) %: GP / Sales.

Sales % – COGS % = GP %.

Chapter 11: Property, Plant, and Equipment (PP&E)

Capitalize: Anything that increases useful life, improvements, additions.

Commercial Substance: Fully recognize gain/loss.

Capitalize cost of land: Cost of land, cost of title transfer, attorney fees, demolition of old building.

Don’t capitalize appraised value & scrap.

Chapter 12: Depreciation Methods

Straight-Line (STL): (Cost – Salvage Value) / Useful Life.

Double-Declining Balance (DDB) Year 1: Cost * (2 / Useful Life).

DDB Year 2: (Cost – Year 1 Depreciation) * (2 / Useful Life).

Sum-of-the-Years’ Digits (SYD) Year 1: (Cost – Salvage Value) * (Useful Life / SYD).

SYD: n(n+1) / 2.

SYD Year 2: (Cost – Salvage Value) * (Useful Life – 1) / SYD.

Units of Production: (Cost – Salvage Value) / Useful Life in Units = Rate -> Units Produced * Rate.

Selling Price – Book Value (BV) of Asset = Gain/Loss on Sale of Asset.

BV = Original Cost – Accumulated Depreciation.

Impairment Loss: 1. Determine if asset is impaired. 2. Measure -> If recoverable cost < BV -> Write down amount = Fair Value (FV) – BV.

Respectively STL = Cost – (Depreciation * # Years).

Practice Exam Notes

Debt to Equity Ratio decreases when gain on land, credit A/R.