Financial Accounting for Economists

Chapter 1: Accounting in Business

Explain the role of accounting in the information age.
Accounting is an information and measurement system. It identifies, records,
and communicates relevant, reliable and comparable information about
business activities. Accounting also includes the crucial process of analysis
and interpretation
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Identify the users and uses of accounting information.

There are two general types of users of accounting information. (1) Internal
users are managers and officers of businesses. They require information
about business activities in order to make decisions about planning,
monitoring, and control. (2) External users rely on financial statements to
make business decisions. These users include lenders, and shareholders.
Lenders need information for measuring the risk and return of loans.
Shareholders need information for assessing the risk and return in owning
shares.

Explain why ethics are an integral part of accounting.

The purpose of accounting is to provide useful information for decision
makers. For information to be useful, it must be trusted. This requires ethical
behavior by accountants and managers in all phases of gathering, analyzing
and reporting financial information so that good decisions are made.

Describe the three important guidelines for revenue recognition.

The three important guidelines for revenue recognition include: (1) Revenue is
recognized when earned. (2) Assets received from selling products and
services do not need to be in cash. (3) Revenue recognized is measured by
cash received plus the cash equivalent of other assets received.

How does the ob&ectivity principle support ethical behavior?

The objectivity principle supports ethical behavior since it requires that financial
information be documented by independent, unbiased evidence. Consequently,
the impact of belief and opinions on the recording and reporting of business
transactions and events is lessened.

How does the going concern principle affect reporting asset values of a business?
The going concern principle means that financial statements reflect an
assumption that the business continues in operation instead of being closed or
sold. Assets are therefore reported at cost rather than at liquidation value.

Describe the relation bet0een revenues, expenses, and net income.

Revenues are the increases in equity from a company's earnings activities.
Expenses are the costs of assets or services used to earn revenues. Net
income is the excess of revenues over expenses.

What distinguishes liabilities from equity?

Liabilities are creditors' claims on assets. They reflect obligations to transfer
assets or provide products or services to others. Equity is owner's claim to
assets. Equity is also called net assets or residual interest or net worth

Describe the three types of activities reported on the statement of cash flows.
The three types of activities reported in the statement of cash flows are (1)
operating, which are the cash inflows and outflows from operations; (2)
financing, which are the cash inflows and cash outflows related to owner
investments and long-term borrowing and repaying cash from lending and (3)
investing, which represent the cash inflows and outflows from the purchase and
sale of long-term assets.

Identify and describe the four basic financial statements.

The four basic financial statements are the statement of financial position,
income statement (statement of comprehensive income), statement of changes
in equity, and statement of cash flows. The statement of financial position
describes the company's financial position and lists the types and amounts of
assets, liabilities, and equity at a point in time. The income statement describes
the company's revenues, expenses, and net income over a period of time. The
statement of changes in equity explains changes in equity from net income or
loss, and from issuance of shares and dividends over a period of time. The
statement of cash flows reports on cash flows for operating, investing, and
financing activities over a period of time

Chapter 2: Analyzing and Recording Transactions

List the steps in processing transactions.
Business transactions and events are the starting point. Source documents
are analyzed for the effects of the transactions and events on the accounting
records. The information is recorded into the journal. The information is then
posted to the accounts and a trial balance is prepared. The final step is the
preparation of financial statements and reports for decision makers
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Describe source documents and their purpose.

Source documents are the sources of information that identify and describe
transactions and events. They provide objective and reliable evidence about
transactions and their amounts. Examples of source documents include
checks, invoices, sales receipts, credit card statements, and bank statements.
They can be in hard copy or electronic form

Explain the difference bet0een a ledger and a chart of accounts.

A ledger is a record containing all of the accounts of a business and their
balances. The chart of accounts is a list of all of the accounts in the ledger that
includes an identification number for the accounts.

Explain the recording and posting processes.

Information from business transactions and events is recorded in the journal in
the form of journal entries. The journal entries include the date, the account
titles, and debit and credit amounts. Fournal entries may also include a further
description of the transaction. During the posting process the debit and credit
amounts recorded in the journal are transferred to the individual accounts in
the ledger.

What is a trial balance? What is its purpose?

The trial balance is a list of all of the accounts in the ledger with balances at a
point in time. The list is organized by debit and credit balances. The purpose of
the trial balance is to summarize the account totals and to verify the accuracy of

the total debits and credits. If the total debits and credits are not equal, then the
trial balance is out of balance which indicates an error in the accounting records.
However, even if debits do equal credits this is no guarantee that no errors were
made in recording and posting transactions.
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Describe the link between the income statement, the statement of changes in equity,
and the statement of financial position.
The income statement reports a company's revenues and expenses along with
the resulting net income or loss. A statement of changes in equity reports
changes in equity, including that from net income or loss. Both statements report
transactions occurring over a period of time. The statement of financial position
describes a company's financial position (assets, liabilities, and equity) at a point
in time. The equity amount in the statement of financial position is obtained from
the statement of changes in equity

Topic 3: Corrections of Errors

Identify and explain the key components of income for a merchandising company.
The basic components of income begin with net sales. Cost of goods sold is
subtracted from net sales to get gross profit (also called gross margin). Other
expenses are then subtracted from gross margin to determine net income
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Describe the difference between wholesalers and retailers.

A wholesaler is an intermediary that buys products from manufacturers and sells
to retailers or other wholesalers. A retailer is an intermediary that buys products
from manufacturers or wholesalers and sells them to consumers

Describe the key attributes of inventory for a merchandising company.

Merchandise inventory is a current asset that represents products a company
owns and intends to sell. Its costs include all necessary expenses to buy the
inventory, ship it to the store, and make it ready for sale.

List the steps of the operating cycle for a merchandiser with credit sales.
The steps are (1) cash purchases of merchandise (2) inventory for saleE (3)
credit sales (4) accounts receivable (5) cash collection.

What is the difference bet0een the periodic and perpetual inventory systems?
A periodic inventory system updates the inventory account only at the end of a
period. A perpetual inventory system continually updates accounting records
for merchandise transactions. The perpetual inventory system is increasing in
popularity due to technological advances and competitive pressures

What does FOB stand for? Differentiate between FOB shipping point (or FOB
factory) and FOB destination.
FOB stands for free on board . If goods are shipped FOB shipping point,
ownership transfers to the buyer when the goods depart the seller's place of
business, and the seller records revenue at that time. The buyer is then
responsible for paying shipping costs and bearing the risk of damage or loss
when goods are in transit. If goods are shipped FOB destination, ownership
transfers to the buyer when the goods arrive at the buyer's place of business.
The seller is responsible for paying shipping costs and bears the risk of
damage or loss in transit. The seller does not record revenue until the goods

arrive at the destination because the transaction is not complete

What is inventory shrinkage? How do managers account for shrinkage?
Inventory shrinkage is the loss of merchandise inventory due to theft or
deterioration or similar phenomena. Inventory shrinkage is typically added
(debited) to the cost of goods sold and merchandise inventory is reduced
(credited) for the amount of the shrinkage.
Distinguish between selling expenses and administrative expenses.
Selling expenses include the expenses of promoting sales by displaying and
advertising merchandise, making sales, and delivering goods to customers.
Administrative expenses support a company's overall operations and include
expenses related to accounting, human resource management, and financial
management