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:
- Identify contracts (approved, payment terms, collection probable, obligations are defined, commercial substance).
- Identify performance obligations.
- Determine transaction price.
- Allocate transaction price to performance obligations.
- 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.