*Define and differentiate the accrual method and cash method of recording transactions.

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1 Accounting 1 *Define and differentiate the terms accounting, auditing, and bookkeeping: --Accounting the process of recording, reporting and analyzing financial transactions. --Bookkeeping the process of documenting the flow of resources into and out of a business, and the claim of creditors and owners to those resources. --Auditing a special area of accounting that deals with verifying the records that are kept and any computations that are made. *Define and differentiate the accrual method and cash method of recording transactions. -- Accrual accounting transactions are recorded at the time they occur.! -Revenue and expenses are recorded regardless of whether cash is received or disbursed during the! account period! -This is used most of the time -- Cash accounting transactions are recorded when money transfers hands.! -Revenue and expenses are recorded in the period in which they are actually received or expended.! -Used only in very limited situations *Define and differentiate revenue and expenses. --Revenue the measurement of goods sold or services rendered for which the business receives cash or the promise of cash. --Expenses the measurement of resources used up during a period of time in order to earn revenue.! Revenue - Expenses = Income *Define and recognize asset accounts, liability accounts and owner equity accounts. --Assets represent resources that are owned by the business.!! Ex: Cash, Accounts receivable, Building, Inventory, Equipment --Liabilities represent debts owed by the business to creditors.! -Liabilities arise when a business borrows cash or purchases goods or services on credit.! -Different from expenses that are incurred on a monthly basis (telephone, lights, rent etc. These are! expenses)!!! Ex: Accounts payable, notes payable --Owner s Equity represents the claim of the owners to the assets of the business, after the creditors have been paid.! -Also known as net worth! -Increases when owners make investments in the business.! -Increases when revenue is earned.! -Decreases when expenses are paid.!! Ex: Contributed capital, sales revenue, service revenue, expense accounts

2 *Explain the fundamental accounting equation. --mathematical expression used to describe the relations between assets, liabilities and owner s equity.! -Uses only real accounts Accounting 2 *Explain how amounts are added to and deleted from T accounts. -- T accounts are used to simplify entries and their effects on various accounts. --Entries are recorded on the appropriate side of the T as either a debit or a credit. *Define debit and credit. Know which side of the T account each is located. --Debits (Db) are entries on the left side of a T account. --Credits (Cr) are entries on the right side of a T account.! For Asset accounts:!!! For Liability and Owner s Equity accounts: **On the exam we will need to say whether or not a particular transaction should be posted as a debit or posted as a credit to the corresponding account, we will have a formula sheet that we can use a scratch paper.**

3 *Explain the effect of revenue, accounts payable and owner contributions made on owner s equity. --Revenue brought into the business has a positive effect on owner s equity: Posted to the left side of the asset account, and to the right side of the OE account. --Accounts payable (anything that we owe somebody)! Ex: Paying a drug wholesaler s bill-- This decreases our cash, which decreases our owner s equity,! this does not mean that it necessarily gets posted to our owner s equity account. It also decreases! our liability, in this example, this transaction would be posted to our liabilities, and assets accounts. --Owner s contributions: Increases owner s equity *Given a description of a transaction, journalize and post to the proper accounts. --Steps to recording transactions:! -Mental analysis:!! What accounts are affected? Asset, Liability or Owner s Equity!! How is the account affected? Tells you whether to enter the transaction on the debit or credit!! side of the T account! -Journaling:!! Write a brief description of the transaction for reference in the future! -posting!! Recording the transaction in the ledger! -Trial balance!! Determine the balance of each T account!! Note whether the balance in on the debit or credit side of the account!! This is the unadjusted trial balance *Determine the balance of an account and perform an unadjusted trial balance. --First thing we do is, perform the unadjusted trial balance, which is to add an subtract all of the transactions that have occurred, and we detemine the balance of the account, and if it is positive or negative.! Do this for all of the assets, liabilities, and owner s equity. This should equal, or a mistake has been! made **Any time that we pay off something that we owe, we are decreasing our owner s equity. **For the purpose of the test, when we are asked to post an expense such as a phone bill, we need to know that our assets are being decreased, and so is our owner s equity

4 Accounting 3 *Define and differentiate fixed and current assets. --Current assets: things found at the top of the balance sheet (Cash, accounts receivable, inventory) things that you have right now that if you needed to pay a bill, you would have as cash or you could turn into cash in order to pay a bill --Fixed asset: Something hard an tangible that you own (buildings, vehicles, computers etc.) these depreciate over time, they have a finite life, whereas cash could sit in the bank without depreciation. *Explain why and when adjusting entries are made. --They are made b/c we need to take into the account the expenses that are incurred during the accounting period. Adjusting entries, will allow us to record what we have sold. If we buy 2 million dollars worth of drugs, we need to record the amount that we have sold of that inventory as well. You want to make sure that you have removed this inventory for bookkeeping and taxing purposes. --Prepaid insurance for example can be an asset. If you paid for it in the middle of the year, you need to make sure that you remove half of that from your books..because you will only have half of that value going into the next accounting period. --Depreciation is another expense. *Given an adjusting entry, record it in the proper accounts. *Perform an adjusted trial balance. **Current assets = Cash, accounts receivable, and inventory** **Only adjust for salary if the last day of the accounting period and pay period fall on different days.** *Explain how and when income is measured in the accounting period --Income is going to be measured after all expenses have been accounted for --Income cannot be measured at the end of the UNadjusted trial balance, because you have not taken into account the expenses of inventory that is going to be taken off the book, any salaries owed, and you have not reduced the value of your assets through depreciation. We want to make sure that all of the expenses have been recorded at the last day of the accounting period so that we can make sure that all of the expenses have been subtracted from the revenue in order to generate our our net income.! ** Revenue - Expenses = Income**

5 **Continued from the previous page** Accounting 4 *Describe the purpose of and what information the income statement presents. --Also known as income and expense statement --Records a business revenues and expenses during an accounting period --Provides a summary of the income earned during the accounting period --Consists of nominal accounts (Revenue and expense accounts) --Has 6 sections --All accounts will be zeroed out at the end of the accounting period. --All percentages used in a income statement are part to total sales. *Name/recognize the accounts that are used in preparing the income statement. --Revenue and expense accounts *Name and describe the six major sections of an income statement. --The Heading of an income statement gives the name of the business and the accounting period. --Revenue (AKA-Sales)! -Money earned by the business! -Rx, OTC, Cognitive services --Cost of Goods Sold (COGS)! -Usually the largest expense of a business! -Typically 75% of revenue --Gross Margin (Gross Profit Margin)! -Revenue COGS = GPM! -Must cover expenses incurred during the accounting period --Expenses! -Salary expenses! -Operating expenses --Net Profit (NP)! -Gross profit margin Total expenses = NP! -Net profit does not always equal net income!! -Income tax must be paid on net profit earned by the business entity

6 !!! -Sole proprietors and partnerships are personally responsible for the tax burden of the!!! profit!!! - Corporations pay income tax on net profit earned prior to profit distribution *Explain why and when closing entries are made. --Dated the last day of the accounting period --Made after all income is measured! -Adjusting entries are made 1 st, closing entries are made 2 nd --They are made so that all expenses can be accounted for, for the revenue that has been generated --Net income can be accurately calculated at the end of the accounting period --They are used to find what the retained earnings of the business are *Given a closing entry, record it in the proper accounts. 1. Record the balance of each revenue and expense account in the Owner s Equity account. 2. If account has a credit balance, debit the account for the amount, and credit retained earnings for the same amount. 3. If account has a debit balance, credit the account for that amount, and debit retained earnings for that amount. 4. Balance retained earnings to record income for the business during the accounting period. *Explain the purpose of the retained earnings account. --Does not appear on the income statement, but it is the link b/t the income statement and the balance sheet *Describe the purpose of and what information the balance sheet represents. --Presents the financial position of a business at any particular point in time --Constructed using all asset and liability accounts, along with owner equity accounts of contributed capital and retained earnings --Has 5 sections --Tells you how much the business is worth *Name/recognize the accounts that are used in preparing the balance sheet. -- Real Accounts! -Assets, liabilities, and your owner s equity accounts.

7 *Name and describe the five major sections of the balance sheet. --Heading: Name of business, accounting period --Assets: Current, Fixed, Goodwill --Liabilities: Current and Long-term --Owner s equity:! -Retained earnings: link b/t the income statement and balance sheet! -Contributed capital --Liabilities PLUS owner s equity: A = L + OE Financial Analysis *Define the four types of financial statements --Income Statement records a company s revenues and expenses during an accounting period. --Balance Sheet is an itemized statement listing total assets and total liabilities of a company and portrays the company s net worth at any moment in time. --Statement of Owner s Equity reports how a company s retained earnings have changed over some period of time. --Statement of Cash Flow reports the amount of cash receipts (cash in) and payments (cash out) during an accounting period.! -Is often used as an tool to assess the short-term viability of a company! *Define ratio analysis, vertical financial analysis and horizontal financial analysis Ratio analysis: --Is a tool needed to assess the financial performance of a company. --Is computed by dividing one financial statement item by another. --Allows for comparisons to be made between a company s historical performance and an industry expected performance. --Vertical analysis compares the financial ratios of a company over time to its own historical performance. --Horizontal analysis compares the financial ratios of one company to ratios of other similar companies and/or to industry standards. *Describe solvency, liquidity and profitability --Solvency examines a company s ability to meet long-term financial obligations (anything longer than 30 days). -- Liquidity examines a company s ability to meet short-term financial obligations (lees than 30 days).! -Cash is the MOST liquid asset, inventory is the LEAST liquid of current assets --Profitability examines a company s ability to make money.! -A business can be very profitable, but not solvent. Solvency involves a businesses ability to make! money and also manage it.

8 *Based the appropriate financial data, conduct a ratio analysis and identify any actual or potential financial problems. --Dr. Bonner will give us formulas but we need to know what quick assets are, where to find the appropriate information on the balance sheet, and identify problems.! -Ex: If a company has a good current ratio, and a bad quick ratio, than the problem is that they need! to most likely have too much money tied up in inventory. --Current Ratio: Measure the ability to meet currently maturing obligations! - Current assets / Current liabilities --Acid-Test ratio (AKA quick ratio): Measures instant debt-paying ability.! - Quick assets / Current liabilities! - Only cash and accounts receivable are the assets in this case --Accounts Receivable (AR) turnover measures the efficiency of collecting receivables and managing credit.! -Indicates on average the # of times monies owed is collected.! -Net sales on account / Average AR! -If AR rate is low, then the AR days are going to be high. If we have a have a low AR rate, and a high! AR turnover days then that is indicative of a pharmacy that is having difficulty collecting money that it! owed to it. This could be from patients having too high of a credit limit, or it could also mean that you! are not collecting from your third party insurers at a quick enough rate. --Accounts Payable (AP) turnover measures the efficiency of paying financial obligations.! -Indicates on average the # of times financial obligations are paid in full! - Cost of goods sold / Average AP! - If you have a low AP turnover rate and a high AP turnover days, then that says that in general, the! company is having a hard time paying its bills on time. This could be related to AR rates. --AP turnover days measures the efficiency of paying financial obligations.! -Indicates how often financial obligations are paid in full.! / AP turnover --Inventory turnover rate measures the efficiency of inventory management.! -Tells you how many times per year you bought/sold your inventory! - Cost of goods sold / Ave. inventory ( Beg. + Ending / 2 )! - Inventory should be turned over 9-10 times per year (less than 40 days). If the turnover rate is 4-5! then that means that money is tied up for too long and cannot be used to pay bills. Also if the! turnover rate is too high then this means that there will be times when you will not have enough! products on the shelf b/t orders. --Inventory turnover days- measures the efficiency of inventory management.! -Tells you on average how many days inventory is on the shelf before selling.! / Inventory turnover rate *Dr. Bonner will give us most of the formulas for the exam, but we will need to know: -- A = L + OE -- Sales - Cost of goods sold = gross profit margin -- Revenue - Expenses = income