WGU C213 PA & OA Study Guide (2022/2023) (Verified Answers)

Accounting
A system of providing “quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions.”

Accounting Equation
Assets = Liabilities + Owners’ Equity

Accounts Payable
The flip side of accounts receivable—when one company sells on credit, creating for itself an account receivable, the company on the other side of the transaction is buying on credit, creating an account payable.

Accounts Receivable
Amounts owed to a business by its credit customers and are usually collected in cash within 10 to 60 days.

Accrual Accounting
The process that accountants use in adjusting raw transaction data into refined measures of a firm’s economic performance.

Accumulated Depreciation
Reflects the wear and tear, or depreciation, of these items since they were originally purchased.

Accumulated Other Comprehensive Income
The grouped together and reported changes which companies experience increases and decreases in equity each year because of the movement of market prices or exchange rates

Activity-based Costing (ABC)
A method of attributing overhead costs to products based on measurable factors that relate to activities that create overhead costs.

Additional Paid-in Capital
Invested by stockholders that exceeds the par value of the issued shares.

American Institute of Certified Public Accountants (AICPA)
The professional organization of certified public accountants in the United States.

Asset
Probable future economic benefit obtained or controlled by a particular entity as a result of past transactions or events.

Asset Mix
The proportion of total assets in each asset category, is determined to a large degree by the industry in which the company operates.

Asset Turnover
Sales divided by assets and is interpreted as the number of dollars in sales generated by each dollar of assets.

Assets
Assets are the firm’s economic resources, formally defined as “probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events

Assets-to-equity Ratio
Assets divided by equity and is interpreted as the number of dollars of assets acquired for each dollar invested by stockholders.

Audit Committee
Members of a company’s board of directors who are responsible for dealing with the external and internal auditors.

Average Collection Period
Shows the average number of days that elapse between sale and cash collection.

Balance Sheet
A listing of an organization’s assets and of its liabilities at a certain time.

Batch-level Activities
Activities that take place in order to support a batch or production run, regardless of the size of the batch. (starting & stopping, small productions runs = higher cost even if the total amount produced stays the same)

Book Value
The book value of an asset is the asset’s cost minus the asset’s accumulated depreciation.

Bookkeeping
The preservation of a systematic, quantitative record of an activity.

Break-even Point
The amount of sales at which total costs of the number of units sold equal total revenues; the point at which there is no profit or loss.

Capital Budgeting
Systematic planning for long-term investments in operating assets.

Capital Lease Obligations
A long-term liability in the balance sheet.

Cash
Coins and currency as well as the balances in company checking and savings accounts.

Cash Budget
An important tool in helping management plan its cash needs.

Cash Equivalents
Short-term, highly liquid investments such as Treasury bills, commercial paper, and money market funds.

Cash Flow Adequacy Ratio
Cash from operations divided by expenditures for fixed asset additions and acquisitions of new businesses

Cash Times Interest Earned Ratio
A financial analysis tool that indicates the interest payment ability of an entity

Certified Public Accountant
A person who has taken a minimum number of college-level accounting classes, has passed the dreaded CPA exam, and has met other requirements set by his or her state.

Common Stock
Stockholders’ equity investment

Common-size Financial Statements
All amounts for a given year being shown as a percentage of that denominator for the year.

Comparability
Tnformation that becomes much more useful when it can be related to a benchmark or standard

Comprehensive Income
The number used to reflect an overall measure of the change in a company’s wealth during the period

Conservatism
a pervasive factor in accounting, can be summarized as follows: When in doubt, recognize all losses but don’t recognize any gains.

Consistency
The consistency principle states that, once you adopt an accounting principle or method, continue to follow it consistently in future accounting periods.

Contribution Margin
The difference between total sales and variable costs; the portion of sales revenue available to cover fixed costs and provide a profit.

Contribution Margin Ratio
The percentage of net sales revenue left after variable costs are deducted; the contribution margin divided by net sales revenue.

Control Activities
Policies and procedures used by management to meet their objectives.

Control Environment
The actions, policies, and procedures that reflect the overall attitudes of top management about control and its importance to the entity.

Control Procedures
Policies and procedures used by management to meet their objectives.

Controlling
Implementing management plans and identifying how plans compare with actual performance.

Cost Behavior
The way a cost is affected by changes in activity levels.

Cost Drivers
Numerical measure used to reflect the amount of a specific cost that is associated with a particular activity.

Cost Pool
Total cost being generated by a specific overhead cost activity.

Cost of Goods Sold
When a business sells goods to customers, the cost of the goods sold is recorded as an expense

Cost-volume-profit (C-V-P) Analysis
Techniques for determining how changes in revenues, costs, and level of activity affect the profitability of an organization.

Current Assets
Cash, accounts receivable, and inventory.

Current Liabilities
Those obligations expected to be paid within one year, the most common being accounts payable.

Current Portion of Long-term Debt
Some liabilities, such as mortgages, are payable in equal monthly installments over a specified number of years. The portion of these liabilities that is payable within 12 months from the balance sheet date.

Current Ratio
A comparison of current assets (cash, receivables, and inventory) with current liabilities. It is computed by dividing total current assets by total current liabilities.

Debt Ratio
A frequently used measure of leverage, computed as total liabilities divided by total assets.

Debt-to-equity Ratio
Total liabilities divided by total equity and is interpreted as the number of dollars of borrowing for each dollar of equity investment

Deferred Income Tax Liability
The income tax expected to be paid in future years on income that has already been reported in the income statement but which, because of the tax law, has not yet been taxed.

Derivative
A financial instrument, such as an option or a future, that derives its value from the movement of a price, an exchange rate, or an interest rate associated with some other item.

Detective Controls
Internal control activities that are designed to detect the occurrence of errors and fraud.

Differential Costs
Future costs that change as a result of a decision; also called incremental or relevant costs.

Direct Costs
Costs that are specifically traceable to a unit of business or segment being analyzed.

Direct Labor
Wages paid to those who physically work on direct materials to transform them into a finished product and are traceable to specific products.

Direct Materials
Materials that become part of the product and are traceable to it.

Direct Method
reporting the information contained in the last column of the adjustment worksheet

Disclosure
Convey the details in a narrative note without ever including anything in the financial statements themselves.

Discontinued Operations
A company makes a decision to simply get out of a certain line of business completely.

DuPont Framework
A systematic approach to identifying general factors causing ROE to deviate from normal.

EPS
What tells the owner of one share of stock what he or she really wants to know

Earnings Per Share (EPS)
The amount of net income associated with each share of stock.

Economic Value Added
A system of earnings-based compensation

Entity Concept
The idea that personal financial activity is kept separate from business financial activity

Equity
Residual interest in the assets of an entity that remains after deducting its liabilities.

Evaluating
Analyzing results, rewarding performance, and identifying problems.

Executory Contract
It is an exchange of promises about the future.

Expanded Accounting Equation
Assets = Liabilities + Paid-in Capital + (Revenues – Expenses – Dividends)

Expenses
The value of resources used in generating the reported revenue.

External Auditors
Independent CPAs who are retained by organizations to perform audits of financial statements.

Extraordinary Items
Gains and losses that result from transactions that are both unusual in nature and infrequent in occurrence

Facility Support Activities
Activities necessary to have a facility in order to participate in the development and production of products or services; activities are not related to any particular line of products or services. (do NOT increase as production increases)

Financial Accounting
The name given to accounting information provided for and used by external users.

Financial Capital Maintenance
The approach that accountants typically use in computing a company’s income in which inflation is ignored and a company is said to have income when its financial resources increase.

Financial Ratios
Relationships between financial statement amounts

Financial Statement Analysis
Areas in which additional data must be gathered, including details of significant transactions, market share information, competitors’ plans, and customer demand forecasts.

Financial Statements
The three primary financial information documents: the balance sheet, income statement, and statement of cash flows.

Financing Activities
Obtaining resources from owners and providing them a return on their investment, and obtaining resources from creditors and repaying those borrowings

Financing Mix
The percentage of total financing (liabilities plus equity) in each individual category.

Fixed Asset Turnover
Sales divided by average fixed assets and is interpreted as the number of dollars in sales generated by each dollar of fixed assets.

Fixed Costs
Costs that remain constant in total, regardless of activity level, at least over a certain range of activity.

GAAP Oval
A diagram that represents the flexibility a manager has, within GAAP, to report one earnings number from among many possibilities based on different methods and assumptions.

Gain
The amount of a company makes money on activities that are peripheral to its primary operations

Gains
Refers to money made on activities outside the normal business of a company

Generally Accepted Auditing Standards (GAAS)
Auditing standards developed by the PCAOB for public companies and AICPA for private companies.

Going Concern Assumption
allows the readers of financial statements to assume that the company will continue on long enough to carry out its objectives and commitments.

Gross Profit
The difference between the selling price of the product and the cost of the product.

High-low Method
A method of segregating the fixed and variable components of a mixed cost by analyzing the costs at the highest and the lowest activity levels within a relevant range.

Historical Cost Convention
An accounting technique that values an asset for balance sheet purposes at the price paid for the asset at the time of its acquisition

Income From Continuing Operations
the segments of a company’s business that it considers to be normal, and expects to operate in for the foreseeable future

Income Smoothing
The practice of carefully timing the recognition of revenues and expenses to even out the amount of reported earnings from one year to the next.

Income Statement
A company’s financial performance for a specified period of time.

Independent Checks
Procedures for continual internal verification of other controls.

Indirect Costs
Costs normally incurred for the benefit of several segments within the organization; sometimes called common costs or joint costs.

Indirect Labor
Labor that is necessary to a manufacturing or service business but is not directly related to the actual production of the product.

Indirect Materials
Materials that are necessary to a manufacturing or service business but are not directly included in or are not a significant part of the actual product.

Indirect Method
A method for creating a statement of cash flows a company may use during any given reporting period. The indirect method uses accrual accounting information to present the cash flows from the operations section of the cash flow statement.

Intangible Assets
Assets that have no physical or tangible characteristics.

Internal Auditors
An independent group of experts (in controls, accounting, and operations) who monitor operating results and financial records, evaluate internal controls, assist with increasing the efficiency and effectiveness of operations, and detect fraud.

Internal Control Structure
Policies and procedures established to provide management with reasonable assurance that the objectives of an entity will be achieved.

Internal Earnings Targets
Financial goals established within a company.

Internal Revenue Service (IRS)
The government agency responsible for tax collection and tax law enforcement.

International Accounting Standards Board (IASB)
An independent, international body formed to develop worldwide accounting standards.

International Financial Reporting Standards (IFRS)
The accounting standards produced by the IASB.

Inventory
The name given to goods held for sale in the normal course of business.

Investing Activities
Cash inflows and outflows from (1) acquiring and selling productive assets such as property, plant, and equipment, (2) acquiring and selling investment securities, and (3) lending money and collecting on those loans

Investment Securities
Composed of publicly traded stocks and bonds.

Leverage
Borrowing that allows a company to purchase more assets than its stockholders are able to pay for through their own investment.

Liabilities
the future sacrifices of economic benefits that the entity is presently obliged to make to other entities as a result of past transactions or other past events

Liability
Probable future sacrifice of economic benefit arising from a present obligation of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.

Liquidity
A company’s ability to pay its debts in the short run

Liquidity
the ease with which the item can be turned into cash

Long-term Debt
Long-term notes, bonds, mortgages, and similar obligations on the balance sheet

Long-term Investments
Those assets that you expect to still be around next year when you prepare the balance sheet again.

Loss
The amount a company loses on activities that are peripheral to its primary operations

Losses
Refers to money lost on activities outside the normal business of a company

Managerial Accounting
The name given to accounting systems designed for internal users.

Manufacturing Overhead
All costs incurred in the manufacturing process other than direct materials and direct labor.

Margin
The profitability of each dollar in sales

Matching
The concept typically used in practice to determine when an expense should be recognized

Materiality
the question of whether an item is large enough to make any difference to anyone

Visual-fit Method
A method of segregating the fixed and variable components of a mixed cost by plotting on total costs at several activity levels and drawing a regression line through the points. (scattergraph)

Mixed Costs
Costs that contain both variable and fixed costs components.

Multiple-step Income Statement
The multi-step income statement includes multiple sub-totals within the income statement.

Net Assets
total assets minus total liabilities. In a sole proprietorship the amount of net assets is reported as owner’s equity. In a corporation the amount of net assets is reported as stockholders’ equity.

Net Income
The accountant’s attempt to summarize in one number the overall economic performance of a company for a given period.

Net Loss
the difference between revenues and expenses. If revenues exceed expenses, net income results. If, on the other hand, expenses exceed revenues, there will be a net loss

Non-cash Investing and Financing Activities
Some investing and financing activities affect a company’s financial position but not the company’s cash flows during the period.

Noncontrolling Interest
Arises when a corporation has subsidiaries that are not 100 percent owned by the corporation.

Notes to Financial Statements
These provide additional information pertaining to a company’s operations and financial position and are considered to be an integral part of the financial statements.

Number of Days’ Sales in Inventories
Calculated by dividing average inventory by average daily cost of goods sold and is interpreted as the average number of days of sales that can be made using only the supply of inventory on hand.

Operating Activities
All transactions relating to a company’s delivering or producing its goods for sale and providing its services

Operating Income
Measures the performance of the fundamental business operations conducted by a company and is computed as gross profit minus operating expenses except for interest and taxes.

Operating Leverage
The extent to which fixed costs replace variable costs as part of a company’s cost structure; the higher the proportion of fixed costs to variable costs, the faster income increases or decreases with changes in sales volume.

Operational Budgeting
Managerial planning decisions regarding current and immediate future (a year or less) operations that are characterized by regularity and frequency.

Opportunity Costs
The benefits lost or forfeited as a result of selecting one alternative course of action over another.

Organizational Structure
Lines of authority and responsibility.

“Other Assets”
Long-term assets that are not suitable for reporting under any of the previous classifications

Out-of-pocket Costs
Costs that require an outlay of cash or other resources.

Owners’ Equity
The owners’ residual interest in the assets of a firm.

Paid-in Capital
The value of the assets given in exchange for shares of stock.

Par Value
The market value of the shares at issuance.

Per-unit Contribution Margin
The excess of the sales price of one unit over its variable costs.

Period Costs
Costs not directly related to a product, service, or asset. They are charged as expenses to the income statement in the period in which they are incurred.

Physical Capital Maintenance
income is earned only when one experiences an increase in actual physical resources.

Physical Safeguards
Physical precautions used to protect assets and records.

Planning
Outlining the activities that need to be performed for an organization to achieve its objectives.

Preferred Stock
Stockholders’ equity investment

Prepaid Expenses
Payments in advance for business expenses.

Preventative Controls
Internal control activities that are designed to prevent the occurrence of errors and fraud.

Price-earnings Ratio
an equity valuation multiple. It is defined as market price per share divided by annual earnings per share.

Pro Forma
A prediction of what the actual cash flow statement will look like in future years if the operating, investing, and financing plans are implemented.

Product Costs
Costs associated with products or services offered.

Product-line Activities
Activities that take place in order to support a product line, regardless of the number of batches or individual units produced. (production complexity)

Production Prioritizing
Management’s continual evaluation of various product lines and divisions’ profitability in order to analyze and identify opportunities to improve profits.

Profit Graph
A graph that shows how profits vary with changes in volume.

Property, Plant, and Equipment
Exactly what the label implies: land, buildings, machinery, tools, furniture, fixtures, and vehicles used by a company in conducting its business activities.

Public Company Accounting Oversight Board (PCAOB)
Board of five full-time members established by the Sarbanes-Oxley Act to oversee the accounting and auditing profession.

Recognition
Boil down all the estimates and judgments into one number and report that one number in formal financial statements.

Regression Line
On a scattergraph, the straight line that most closely expresses the relationship between the variables.

Relevance
A qualitative characteristic in accounting. Relevance is associated with information that is timely, useful, has predictive value, and is going to make a difference to a decision maker.

Relevant Range
The range of operating level, or volume of activity, over which the relationship between total costs (variable plus fixed) and activity level is approximately linear.

Reliability
A qualitative characteristic in accounting. It is achieved when information is verifiable, objective (not subjective) and you can depend on it.

Restructuring Charges
The fact that companies have exercised considerable discretion in determining the amount and timing of a restructuring charge.

Retained Earnings
The cumulative amount of a corporation’s profits that have been reinvested on behalf of the stockholders

Return On Assets
Net income divided by total assets and is the number of pennies of net income generated by each dollar of assets.

Return On Equity
The overall measure of the performance of a company.

Return On Investment
A measure of operating performance and efficiency in utilizing assets; computed in its simplest form by dividing net income by average total assets (also known as return on assets or ROA).

Return On Sales
Net income divided by sales and is interpreted as the number of pennies in profit generated from each dollar of sales.

Return On Sales Revenue
A measure of operating performance; computed by dividing net income by total sales revenue. Similar to profit margin.

Revenue
The value of the goods and services provided by a company in its business operations.

Revenue Recognition
a cornerstone of accrual accounting together with matching principle. They both determine the accounting period, in which revenues and expenses are recognized.

Sales Discounts
Are cash reductions offered to customers who purchase merchandise on account and who pay their bill early.

Sales Mix
The relative proportion of total sales dollars (or total units sold) that is represented by each of a company’s products.

Sarbanes-Oxley Act
A law passed by Congress in 2002 that gives the SEC significant oversight responsibility and control over companies issuing financial statements and their external auditors.

Scattergraph
A method of segregating the fixed and variable components of a mixed cost by plotting on total costs at several activity levels and drawing a regression line through the points.

Securities and Exchange Commission (SEC)
The government body responsible for regulating the financial reporting practices of most publicly owned corporations in connection with the buying and selling of stocks and bonds.

Segregation of Duties
A strategy to provide an internal check on performance through separation of authorization of transactions from custody of related assets, operational responsibilities from record-keeping responsibilities, and custody of assets from accounting personnel.

Short-term Loans Payable
Formal, interest-bearing loans that are expected to be paid back within one year.

Single-step Income Statement
With this format, all revenues are grouped together, all expenses are grouped together, and net income is computed as the difference between total revenues and total expenses.

Statement of Cash Flows
Individual cash flow items that are classified according to three main activities: operating, investing, and financing.

Statement of Cash Flows
Summarize a company’s cash flows for a period of time.

Stepped Costs
Costs that change in total in a stair-step fashion (in large amounts) with changes in volume of activity.

Stockholders’ Equity
The difference between assets and liabilities in a corporation

Strategic Planning
Broad, long-range planning usually conducted by top management.

Sunk Costs
Costs that are past costs and do not change as a result of a future decision.

Target Income
A profit level desired by management.

Time Period Concept
The time period principle is the concept that a business should report the financial results of its activities over a standard time period, which is usually monthly, quarterly, or annually.

Transaction Analysis
The process of determining how an economic event impacts the financial statements

Treasury Stock
The repurchased shares when a company buys back its own shares

Turnover
The degree to which assets are used to generate sales

Unearned Revenue
Represents Sears’s obligation to provide service to customers who have paid Sears for a service they have not yet received.

Unit-level Activities
Activities (routine) that take place each time a unit of product is produced. (The more production, the higher these cost)

Valuation
Once it has been determined that an item should be recognized in financial statements, the question then arises about what dollar amount to assign to the item.

Variable Cost Rate
The change in cost divided by the change in activity; the slope of the regression line.

Variable Costs
Costs that change in total in direct proportion to changes in activity level.

External Audit
audit conducted by external (independent) qualified accountant(s)

Financial Accounting Standards Board (FASB)
Private, non-profit body that sets accounting standards in the United States.

Accounting is the recording of the day-to-day financial activities of a company and the organization of that information into summary reports used to evaluate the company’s financial status.
Describe the purpose of accounting.

Bookkeeping is a part of accounting. Bookkeeping refers to the process of recording transactions into various accounts, which is the first step in accounting. The next step is to analyze the accounts and organize them into financial statements and other useful reports.
What is the difference between bookkeeping and accounting?

The balance sheet reports a company’s assets, liabilities, and owners’ equity. It reports the financial position of a firm at a point in time.

The income statement reports the amount of net income earned by a company during a period. Net income is the excess of a company’s revenues over its expenses. It reports the financial performance of a firm over a period of time.

The statement of cash flows reports the amount of cash collected and paid out by a company in the following three types of activities: operating, investing, and financing over a period of time.
Describe the three financial statements.

Lenders
Investors
Company Management
Suppliers and Customers
Employees
Competitors
Government Agencies
Politicians
Press
Identify users of financial statements

CPA Accreditation
The American Institute of Certified Public Accountants (AICPA) is the professional organization of certified public accountants (CPAs) in the United States.

sets ethical standards for CPAs, provides continuing education for them, writes and grades the CPA exam, lobbies for legislation favored by CPAs, and provides other support to CPAs. Its oversight of the CPA exam is its main role in accreditation.
The AICPA

meet the requirements of the state in which you plan to practice. The requirements for each state are set by that state’s legislature and overseen by that state’s Board of Accountancy, which is a state agency.
To be accredited as a CPA you must

Globalization – As more and more business do business globally, capital flows more freely across national boundaries.

Technology – Information technology has speeded up the pace with which accounting data and reports are produced and dramatically increased the volume of accounting information that firms can provide to investors.
Describe current trends that are causing changes in the field of accounting.

The three main sections of the Balance Sheet are Assets, Liabilities, and Equity.
Identify components of a balance sheet.

whether the asset is expected to be consumed or the liability paid within a year. Assets expected to be consumed and liabilities expected to be paid within a year are current and those that will be consumed or paid after a year are long-term.
On the balance sheet, both assets and liabilities are further separated into current and long term based on

paid in capital (also referred to as capital stock) and retained earnings. Paid in capital also is referred to as contributed capital while retained earnings is earned capital.
On the balance sheet, equity is separated into

an owner buys stock from the firm.
Paid in capital is created when

the accumulated earnings of the firm (i.e., net income over time) that have not been paid back in dividends.
Retained earnings are

The Balance Sheet equation:
Assets = Liabilities + Equity.

Given values for any two of the three components, you can always calculate to the third component using this equation. For example, if you know a firm’s total assets and liabilities, you can calculate owners’ equity by: Assets – Liabilities = Equity
How do you use the accounting equation to calculate total assets, total liabilities, or total stockholders’ equity?

The Income Statement describes a company’s financial performance for a period of time. A company’s expenses are subtracted from its revenues and gains and losses are also factored in computing net income.
Identify components of the income statement.

the change in retained earnings between two Balance Sheet dates, along with dividends and unrealized gains and losses. The accountant’s attempt to summarize in one number the overall economic performance of a company for a given period.
Net income helps explain

A single step income statement lumps all revenues together and subtracts all expenses to calculate net income. A multiple-step presents subtotals that highlight key performance measures.
What is the difference between a single-step income statement and a multi-step income statement?

Sales or revenues

Cost of goods sold (COGS) (Product costs of items sold)
= Gross profit
Selling and Administrative expenses (also called operating expenses)
= Operating income or earnings before interest and taxes (EBIT)
Other income – other expenses + gains – losses
= Earnings before taxes (EBT)
Taxes
= Net Income (Profit)
A multiple-step income statement includes:

subtracted from all the income statement line items and the income statement will include another subtotal – income from continuing operations that will be followed by a single line item that presents to effects of the extraordinary item discontinued operations and then net income.
If the firm has experienced a discontinued operation or extraordinary item, the effects of these events are

The Statement of Cash Flows details how a company obtained and spent cash during a certain period of time. Thus, the cash flow statement explains the change in the firm’s cash account for a period of time. All of a company’s cash transactions are categorized as either operating, investing, or financing activities.
Identify components of the cash flow statement.

those related to a firm investing in itself (purchasing and selling property, plant, and equipment or other businesses) and investing in others (buying the stocks and bonds of another firm or lending another firm money).
Investing cash flow are

those associated with someone investing in your firm, either stockholders (buying and selling your stock and paying dividends) and creditors (borrowing and paying back debt).
Financing cash flows are

There are four main areas that must be covered in the financial statement footnotes:

A summary of significant accounting policies.
Additional information about the summary totals found in the statements.
Disclosure of important information not recognized in the statements.
Supplementary information required by the Financial Accounting Standards Board (FASB) or the Securities and Exchange Commission (SEC).
Explain the purpose of notes to financial statements.

The independent accounting firm conducts tests to determine whether the financial statements fairly reflect the financial status of the company issuing them and whether the financial statements were prepared using Generally Accepted Accounting Principles (GAAP).
Describe the purpose of an external audit.

In some cases, laws and regulations mandate that they do so. Aside from regulations, firms benefit when raising funds through stock sales or by borrowing by being able to show the potential investor or creditor that their financial statements have been audited because that increases the credibility of those financial statements.
Firms hire independent external auditors for a variety of reasons:

Direct matching
Systematic and Rational allocation
Direct Expensing
The three main matching principles are:

Direct matching
This principle applies to product costs, which are recorded in cost of goods sold for the period. A firm will calculate the cost of producing each product and place the item and its costs in inventory. When the item is sold, the costs as well as the item come out of inventory. The item is delivered and the costs included in cost of goods sold. Thus, the product’s costs are directly matched to its selling price in the period it was sold and the revenue recognized.

Systematic and Rational allocation
This principle applies to period costs and allocates the cost of a previously purchased asset to the period for which use of the asset contributed to revenue generation. The two main examples are depreciation on non-production property, plant, and equipment and prepaid (PPE) expenses. The depreciation on production PPE is included with product costs and directly matched to revenue when the product is sold.

Direct Expensing
Direct expensing applies to period costs except for those that are systematically allocated. Any expense that contributed to generating revenue in a period is included in the income statement for that period, i.e. matched to the revenue it helped generate. Direct expensing applies selling, general, and administrative activities like paying non-production employees, insurance on non-production activities and assets, advertising, and interest.

The statement of cash flows explains how a company’s cash was generated during the period and how that cash was used. Explains change in cash account between two balance sheet dates.
Describe the purpose of the statement of cash flows.

All of a company’s cash transactions are categorized as either operating, investing, or financing activities.
Identify the categories of a cash flow statement.

those associated with any activity on the income statement. The operating section of the cash flow statement is what the income statement would show if the income statement were prepared on a cash basis and not accrual basis. In addition, since current assets and current liabilities tend to be linked to revenues and expenses on the income statement, any cash flows associated with current assets and liabilities tend to be operating cash flow.
Operating cash flows are

those related to a firm investing in itself (purchasing and selling property, plant and equipment or other businesses) and investing in others (buying the stocks and bonds of another firm or lending another firm money). However, any revenues earned (i.e., interest and dividend income) from investments in other firms is income on the income statement and, therefore, are operating cash flow.
Investing cash flow are

those associated with someone investing in your firm, either stockholders (buying and selling your stock and paying dividends) and creditors (borrowing and paying back debt). However, any interest expense on loan payments is an expense and therefore an operating cash flow. Dividends are not an expense but a transfer of retained earnings back to the owners and are not an operating but a financing cash flow.
Financing cash flows are

Unlike the indirect method, the direct method does not start with net income. Instead, this method reports directly the major classes of operating cash receipts and payments of an entity during a period. The direct method is favored by many users of financial statements because it is easy to understand. The indirect method is favored and used by most companies because it is relatively easy to construct from existing balance sheet and income statement data. In addition, the indirect method highlights the reasons for the difference between net income and cash from operations. In addition, GAAP required this reconciliation and so if a firm uses the direct method, they must present the indirect method in the footnotes anyway, thus having to do the calculations twice.
Describe the differences between the direct and indirect methods of the cash flow statement.

direct method. The operating activities section of a statement of cash flows prepared using the direct method is, in effect, a cash-basis income statement.
The investing and financing cash flows are always prepared using a

net income as reported in the income statement and then details the adjustments needed to arrive at cash flow from operations.
The indirect method begins with

Financial statement analysis can be used to diagnose existing problems and to forecast how a company might do in the future. The financial statement analysis process starts with the financial statements and reviews the ratios and common-sizing results to spot “red flags.”
Describe the purpose of financial statement analysis and financial ratios.

Errors
Disagreement
Frauds
Identify common financial statement errors.

Errors
Result when unintentional mistakes are made in recording transactions, posting transactions, summarizing accounts, and so forth. Errors are not intentional and when detected are immediately corrected. Errors can result from sloppy accounting, bad assumptions, misinformation, miscalculations, and other factors.

Disagreement
Result when different people arrive at different conclusions based on the same set of facts. Because accounting involves judgment and estimates, opportunities for honest disagreements in judgment abound. These disagreements often come about because of the different incentives that motivate those involved with producing the financial statements. For example, there might be differing views about what percentage of reported receivables will be collected or how long equipment and other assets will last.

Frauds
Result from intentional errors. Fraudulent financial reporting occurs when management chooses to intentionally manipulate the financial statements to serve their own purposes, such as meeting Wall Street’s earnings forecasts as was the case with WorldCom.

Meet internal targets
Meet external expectations
Income smoothing
Window dressing for an IPO or a loan
Managers manage earnings to:

Managerial accounting’s main purpose is to provide a firm’s management with information they can use to run the business more efficiently and effectively. However, managers also use financial accounting reports to accomplish these goals as well.
Describe the purpose of management accounting.

Management Accounting:
Unique competitive tool, Both financial and nonfinancial data, Data usually kept secret within the company, Used for internal planning, control, and evaluation

Financial Accounting:
Uniform across companies and based on generally accepted accounting principles, Restricted to financial data, Data often made public, Used primarily by investors and creditors in deciding whether to provide capital to the company
Differentiate between management and financial accounting.

Merchandising companies
buy finished goods and resell them to customers. This category includes wholesalers and retailers.

Service companies
do not produce products but provide services. These companies do not tend to have inventories since inventories are limited to products for resale and they don’t produce products.

Manufacturing company
produce products for resale.

Product costs
All costs used to produce a good or service. These costs include direct materials, indirect materials and manufacturing overhead.

indirect materials and indirect labor plus all other manufacturing overhead. You can identify other manufacturing overhead items because they will be indicated using terms like production, manufacturing, or factory.
Manufacturing overhead include

Period costs
Costs not used to produce a good or service, or capitalized as an asset. They are charged as expenses to the income statement in the period in which they are incurred. Some examples include:
President’s salary
Selling Costs
Office costs
Sales salaries
Advertising
Legal and accounting fees
Dues and subscriptions
Office utility costs
Supplies

Direct materials
Materials that become part of the product and are traceable to it. For example the ice cream in an ice cream cone.

Indirect materials
Materials that are necessary to a manufacturing or service business but are not directly included in or are not a significant part of the actual product. For example, the cleaning supplies used to clean the assembly line at night once it is shut down.

Direct labor
Wages paid to those who physically work on direct materials to transform them into a finished product and are traceable to specific products. For example, the labor costs to assemble the ice cream cones.

Indirect labor
Labor that is necessary to a manufacturing or service business but is not directly related to the actual production of the product. For example, the labor costs to clean up the assembly line at the end of the day.

Manufacturing overhead
All costs incurred in the manufacturing process other than direct materials and direct labor to include indirect materials and labor and any other costs associated with the manufacturing facility. For example, the depreciation on the manufacturing facility. These costs are usually indicated with the term factory, manufacturing, or production.

Differential costs
Future costs that change as a result of a decision; also called incremental or relevant costs. For example, if you are going to buy a new car, the difference between your current insurance premiums and the new insurance premiums.

Sunk costs
Costs that are past costs and do not change as a result of a future decision. For example if a business is buying a new piece of equipment, the depreciation expenses on the old equipment would be sunk and not recoverable.

Opportunity costs
The benefits lost or forfeited as a result of selecting one alternative course of action over another. For example, if you pay cash for your new cash, you give up the opportunity to use the cash to pay for a vacation.

Variable costs
Variable costs, by definition, vary in total proportionately to the number of units sold. However, the variable cost per unit sold is fixed within a relevant range.

Fixed costs
Fixed costs, by definition, stay the same in total as units sold changes. However, because the total fixed costs stay the same, the per-unit fixed costs must vary inversely with units sold. That is, if you sell one more unit and the total fixed costs stay the same, the per-unit fixed costs must fall because you are spreading the same fixed costs over more units. The reverse is true if you sell on less unit.

The main professional association for management accountants is the Institute of Management Accounting (IMA). It has established a code of conduct to help guide management accountants when they fact ethical dilemmas. Their members are ethically required to:

Be competent in their profession
Not disclose confidential information
Act with both actual and apparent integrity in all situations
Maintain objectivity when communicating information to decision maker
Describe the role of key ethical standards in the field of management accounting.

Traditional Costing Method
The traditional costing method applies overhead costs to products based on a predetermined overhead rate. The rate is usually based on a general cost driver like direct labor hours. In short, the traditional method allocates overhead to products based on a single cost driver. That is, it treats overhead costs as a single pool of overhead costs and only uses one cost driver.

ABC Method
More accurate than traditional costing because it does a better job of identifying activities that actually drive overhead costs and how different product’s production methods drive those costs.

A company identifies business activities that create overhead costs, e.g. setting up and shutting down an assembly line.
Measure those costs and accumulate in cost pools. That is a cost pool accumulates the overhead costs of a single overhead generating activity.
Identify a driver, i.e. quantitative measure, of the level of activity like number of setups for setting up and shutting down an assembly line.
Use driver counts per product to allocate cost pools to products.
Make decisions based on the results.
The ABC method is applied in steps as follows:

While ABC is more complex and costly to implement, it is more accurate. The process of developing an ABC system can also help the firm identify problem areas in their production process.
Using ABC tends to be worth the extra cost when a firm produces multiple products that are produced in very different ways (i.e., have fairly complex production processes). If the firm only has one product or if their products are very similar in how they are produced, then ABC may not be worth the time/expense.
Compare and contrast traditional costing to activity-based costing (ABC).

finding a quantitative measure that captures changes in the level of an overhead generating activity. Beyond this general rule, you need to just look at the nature of the activity and think about what might be the right quantities measure that would capture how the activity varies in size.
Identifying the appropriate cost driver for a specific situation is done by

Cost-volume-profit analysis is a technique for determining how changes in revenues, costs, and level of activity affect the profitability of an organization.
Describe cost-volume-profit analysis.

Variable costs – Variable costs, by definition, vary in total proportionately to the number of units sold. However, the variable cost per unit sold is fixed within a relevant range.

Fixed costs – Fixed costs, by definition, stay the same in total as units sold changes. However, because the total fixed costs stay the same, the per-unit fixed costs must vary inversely with units sold. That is, if you sell one more unit and the total fixed costs stay the same, the per-unit fixed costs must fall because you are spreading the same fixed costs over more units. The reverse is true if you sell one less unit.
Describe how basic cost behavior patterns change as sales volumes change.

annual accounting support fees from public companies, as required under the Sarbanes-Oxley Act.
The FASB receives most of its $36 million annual operating budget through

the legal power to enforce the accounting standards it sets.
Because the FASB is not a government agency, it lacks

establish accounting standards for companies soliciting investment funds from the American public. For now, the SEC refrains from exercising this authority and allows the FASB to set U.S. accounting standards.
As part of its regulatory role, the SEC has been granted by Congress specific legal authority to

Corporate Governance
the set of principles and practices that a corporation uses to regulate the relationship between the shareholders and the professional managers hired by the board of directors.

preparing and grading the CPA examination in addition to maintaining the integrity of the accounting profession through its Code of Professional Conduct.
The AICPA is responsible for

the Public Company Accounting Oversight Board (PCAOB).
Section 101 of the Sarbanes-Oxley Act created

an arm of the SEC in registering, inspecting, and disciplining the auditors of all publicly traded companies.
The PCAOB is structured as a private, non-profit organization, but it effectively serves as

the PCAOB.
The SEC appoints the chairperson and members of

registration fees paid by all publicly traded companies in the United States.
Like the FASB, the PCAOB is funded by

the rapid advance in information technology,
the international integration of worldwide business, and
the increased scrutiny associated with the large corporate accounting scandals.
Three factors have combined to make right now a time of significant change in accounting

a group of private investors, sometimes joined by company managers, putting up a small amount of money to buy an entire corporation. The bulk of the purchase price is provided by banks and other lenders, with the assets of the acquired company serving as collateral for the loans.
An LBO (leveraged buyout) involves

buy the company, streamline and improve its operations, and then sell the company back to public investors.
The way to make money in an LBO is to

Investment funds can be accumulated from many different individuals, allowing development of larger and more efficient (sometimes) companies.
Individual owners can buy and sell their ownership shares without getting the permission of the other owners.
The liability of the owners is limited, meaning that if the business fails, the worst that can happen to the owners is that they lose their investment—their other personal assets are not at risk.
The primary advantages of incorporation include the following:
Corporate income is taxed twice—once when it is earned by the corporation and again when it is paid out to shareholders in the form of dividends.
Management of the business is separated from ownership, so the owners have to be wary in monitoring the activities of their hired managers.
The primary disadvantages of incorporation include these:

corporations, although the actual number of proprietorships is greater.
The large majority of business activity in the United States is conducted by

owners investing and withdrawing funds and by company operations generating either a profit or a loss.
Owners’ equity is affected by

Owners invest assets
Company generates a profit
Factors that increase owners’ equity:
Owners withdraw assets
Company suffers a loss
Factors that decrease owners’ equity:

the accounting equation.
The balance sheet is a detailed version of

economic resources controlled by a business / claims against these resources
Another way to view this equality is that the firm’s assets must have sources, and the right-hand side of the equation shows the origin of the resources.
The left-hand side of the accounting equation/balance sheet shows the _________, and the right-hand side shows the _________.

the entity concept,
the historical cost convention, and
the going concern assumption
Three important concepts that underlie the content of all financial statements are particularly relevant to the balance sheet:

current appraised value rather than at historical cost.
International accounting rules allow property, plant, and equipment to be reported at

less than the company’s market value.
Because a balance sheet can underreport the value of some long-term assets, and because other important economic assets are not reported at all, the accounting book value of a company, as measured by the amount of owners’ equity, is usually

how much difference there is between accounting book value and market value; a book-to-market ratio of exactly 1 would indicate that the recorded value of the company is equal to its market value. Most companies in the United States have book-to-market ratios of less than 1.
The book-to-market ratio (computed as owners’ equity divided by total market value of a company’s shares) is a measure of

a distribution of profits to the owners. Therefore, dividends never appear on an income statement.
Dividends are not considered expenses but rather as

quarterly and annually, and private companies prepare financial information at least annually.
In the United States, public companies are required to report

Before recognizing revenue, the promised work must be done, meaning that the goods have been delivered or the service has been provided.
Before recognizing revenue, cash must have been collected, or, alternatively, collection must be reasonably assured.
Accountants use the following two criteria in determining when to recognize revenue:
A summary of significant accounting policies
Additional information about the summary totals found in the statements
Disclosure of important information not recognized in the statements
Supplementary information required by the FASB or the SEC
Financial statement notes are of the following four general types:

Transparency
the ease in which an outsider can tell what is going on inside a process.

audited financial statements and banks often require private companies to have their financial statements audited as a precondition for getting a loan.
The SEC requires all publicly traded companies to provide potential investors with

relevance and reliability.
Many of the hard decisions in choosing appropriate accounting practices boil down to a choice between

long preparation times as information is double-checked and in an avoidance of estimates and forecasts that cloud the information with uncertainty.
Emphasizing reliability results in

the use of instant information full of uncertainty.
Relevance often requires

not isolated lists of numbers but are an integrated set of reports on a company’s financial status.
In an accounting context, articulation means that the three primary financial statements are

the balance sheet cash amount changed from beginning of year to end of year.
The statement of cash flows contains the detailed explanation for why

change in retained earnings shown on the balance sheet.
The income statement, combined with the amount of dividends declared during the year, explains the

net income through the accounting adjustments applied to the raw cash flow data.
Cash from operations on the statement of cash flows is transformed into

liability to be reported in the balance sheet.
Unearned revenue is not revenue at all but a

equity.
The difference between assets and liabilities is called

current market value.
Because of the increased reliability of financial markets in the United States, accounting rules now require almost all investment securities to be reported at

the intangibles that they have developed themselves.
In reporting intangible assets, companies report the intangibles that they have purchased from other companies but not

par value and additional paid-in capital.
The amount invested by common stockholders is frequently divided into

working capital.
The difference between current assets and liabilities is called

a company report the entire amount of interest that has accumulated for the year, whether that interest has been paid in cash or not.
To accurately reflect the interest expense associated with a given year, accrual accounting requires that

an operating expense.
Interest expense has little to do with the essential character of a company’s operations and is not classified as

Income tax expense
the sum of all the income tax consequences of all transactions undertaken by a company during a year. Some of those tax consequences may occur in the current year, and some may occur in future years.

a company selling a long-term asset for more or less than the recorded cost of the asset.
The most common source of gains and losses is

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the computation of net income.
The comprehensive income items do not appear on the income statement and are explicitly excluded from

dividing income available to common shareholders (net income less dividends paid to or promised to preferred shareholders with regard to that reporting period) by the average number of shares outstanding during the period.
Basic earnings per share is computed by

stock options or other rights that can be converted into shares in the future.
Diluted earnings per share reflects the existence of

important profit relationships and income numbers such as gross profit and operating income.
With a multiple-step income statement, the revenue and expense items are arranged to highlight

The promised work must be done before revenue is recognized.
Cash collection should be reasonably assured before revenue is recognized.
Accountants use the following two criteria to determine when revenue should be recognized:
Gross profit
Operating income
Income from continuing operations
Net income
Comprehensive income
Five key measures of income are:

the expanded accounting equation which is:
Assets = Liabilities + Paid-in Capital + (Revenues − Expenses − Dividends)
Individual transactions impacting income can be analyzed using

equity can be decomposed into paid-in capital and retained earnings and that revenues, expenses, and dividends are just temporary subcategories of retained earnings.
The insight behind the expanded accounting equation is that

equity
Revenues increase ; and expenses and dividends represent a reduction in .

what underlying factors determine the level of a revenue or an expense.
Good forecasting requires an understanding of

a forecast of sales, which establishes the expected scale of operations in future periods.
Most financial statement forecasting exercises start with

sufficient cash flows are there to service current needs.
For high growth companies, positive earnings are no guarantee that

looming problems in the future.
The positive cash flow indicates that business can continue for the time being, but the reported loss may hint at

the critical number investors should be looking at when evaluating one of these companies.
Cash from operations is

net amount of cash provided or used by operating activities
The ______________________ is THE key figure in a statement of cash flows.

operating activities. The guiding principle is that the operating activities section contains the cash flow effects of all items included in the income statement.
Although cash inflows from interest revenue and cash outflows from interest expense logically might be classified as investing or financing activities, the FASB decided to classify them as

the nature of the business. The purchase of machinery is an investing activity for a manufacturing business but is an operating activity for a machinery sales business.
Whether an activity is an operating activity depends upon

positive cash flow from operations.
Most companies (over 70 percent in the United States) generate

usually negative (about 85 percent of the time in the United States).
In normal times, most companies use cash to expand or enhance long-term assets, so cash from investing activities is

selling off its long-term assets faster than it is replacing them.
A company with positive cash flow from investing activities is

pay for its capital expansion (investing activities) and also to subsidize negative operating cash flow resulting from a buildup in inventories and receivables.
A young or rapidly growing company requires cash inflow from financing activities in order to

just sufficient to finance the replenishment of long-term assets and to pay dividends to the investors.
In a company that has stopped growing and is focused on maintaining its position, cash from operations is

it can pay for capital expansion and have cash left over to repay loans, pay cash dividends, and even repurchase shares of stock.
A mature, successful company generates so much cash from operations that

Free Cash Flow
Free Cash Flow = Net Cash Flow from Operations – Capital Expenditures

Step 1. Compute the change in the cash balance during the period.
Step 2. Convert the income statement from an accrual basis to a cash basis.
Step 3. Analyze the long-term assets to identify the cash flow effects of investing activities.
Step 4. Analyze the short-term and long-term debt and the stockholders’ equity accounts to determine the cash flow effects of any financing transactions.
Step 5. Prepare a formal statement of cash flows.
Step 6. Report any significant investing or financing transactions that did not involve cash.
This six-step process outlines a systematic method that can be used in analyzing the income statement and comparative balance sheets in preparing a statement of cash flows:

does not start with net income. Instead, this method reports directly the major classes of operating cash receipts and payments of an entity during a period.
Unlike the indirect method, the direct method

indirect
In practice, approximately 95% of large U.S. corporations use the ____ method when reporting cash from operating activities.

The direct method of reporting cash from operating activities is easy to understand. The indirect method is more difficult to understand but it is useful because it highlights the reasons for the difference between net income and cash from operations.
What is the difference between the direct method and the indirect method?

plan ahead as far as timing of new loans, stock issuances, long-term asset acquisitions, and so on.
The cash flow projection allows a company to

evaluate the likelihood that the loan will be repaid and allow potential investors to evaluate the likelihood of receiving cash dividends in the future.
Projected cash flow statements allow potential lenders to

diagnosis—identifying where a firm has problems—and prognosis—predicting how a firm will perform in the future.
Financial statement analysis is both

Debt Ratio Formula
Debt Ratio = Total Liabilities / Total Assets

50 percent, but this benchmark varies widely from one industry to the next
The general rule of thumb is that debt ratios should be around

the current ratio.
The most commonly used measure of liquidity is

Current Ratio Formula
Current Ratio = Current Assets / Current Liabilities

less than 1.
Current ratios for successful companies these days are frequently

Return on Sales Formula
Return on Sales = Net Income / Sales

Asset Turnover Formula
Asset Turnover = Sales / Total Assets

asset turnover.
A financial ratio that gives an overall measure of company efficiency is called

not all economic assets are recorded as assets on the balance sheet. Thus, the denominator of the ratio can be understated, sometimes very significantly.
The computed asset turnover ratio can be misleading because

how much profit they will earn for each dollar they invest.
What investors really want to know is not how many pennies of profit are earned on a dollar of sales or what the current ratio is—they want to know

Return on Equity Formula
Return on Equity = Net Income / Stockholders’ Equity

PE Ratio Formula
PE Ratio = Market Value of Shares / Net Income

10 and 30.
In the United States, PE ratios typically range between

firms for which strong growth is predicted in the future.
High PE ratios are associated with

a comparison of a financial statement number to a market value number.
Note that the PE ratio is different from the other ratios in that it is not the ratio of two financial statement numbers. Instead, PE ratio is

(1) a comparison of two amounts found in the same financial statement (such as return on sales, which compares two income statement amounts) or
(2) a comparison of two amounts from different financial statements (such as asset turnover, which compares an income statement and a balance sheet amount).
The large majority of financial ratios are

three years of income statements and two years of balance sheets when providing financial reports to the public.
The SEC requires publicly traded companies to provide

a percentage of sales for the year.
A common-size balance sheet expresses each amount as

total assets to standardize each amount instead of using total sales, in which case the asset percentages are a good indication of the company’s asset mix.
A common-size balance sheet is often prepared using

the financial status of a company. Return on equity can be interpreted as the number of cents of net income an investor earns in one year by investing one dollar in the company.
Return on equity (net income ÷ equity) is the single measure that summarizes

a company in good health.
As a very rough rule of thumb, return on equity (ROE) consistently above 15 percent is a sign of

a sign of trouble.
ROE consistently below 15 percent is

profitability (Return on sales)
efficiency (Asset turnover)
leverage (Assets-to-equity ratio)
The insight behind the DuPont framework is that ROE can be decomposed into three components:

sales volume.
The amount of inventory a business carries is closely related to

the number of days a business can continue to sell products without receiving any replacement inventory.
The amount of inventory is sometimes expressed in terms of

More borrowing means that more assets can be purchased without any additional equity investment by stockholders.
More assets mean that more sales can be generated.
More sales mean that net income should increase.
More net income means more return for stockholders.
Higher leverage increases return on equity through the following chain of events:

high / low
Investors generally prefer leverage in order to increase the size of their company without increasing their investment, but lenders prefer leverage to increase the safety of their debt.

leverage.
The original DuPont analysis framework developed by F. Donaldson Brown did not consider

assets serve as reliable collateral and for companies that are in more stable lines of business.
Debt ratios vary significantly across industries. In general, they are higher for companies for which

dividing income, before any charges for interest or income tax, by the interest expense for the period. The resulting figure is the number of times a company can make its interest payments—a higher number reflects a greater likelihood that the company can meet future interest obligations.
The times interest earned calculation is made by

Average Collection Period
Number of Days’ Sales in Inventories
Fixed Asset Turnover
Efficiency Ratios

Debt Ratio
Debt-to-Equity Ratio
Times Interest Earned
Assets-to-Equity
Leverage Ratios

accrual accounting assumptions and adjustments have been included in computing net income.
The cash flow-to-net income ratio reflects the extent to which

a value greater than one because of significant non-cash expenses (such as depreciation) that reduce reported net income but have no impact on cash flow.
In general, the cash flow-to-net income ratio will have

remain fairly stable from year to year.
For a given company, the cash flow-to-net income ratio should

accounting assumptions played a role in reducing reported net income.
A significant change in the cash flow-to-net income ratio, such as that reported by DuPont in 2012, indicates that

completely pay for all new plant and equipment purchases with cash left over to repay loans or distribute to investors.
A “cash cow” is a business that is generating enough cash from operations to

the denominator of the cash flow adequacy ratio. With this formulation, the ratio indicates whether operating cash flow is sufficient to pay for both capital additions and regular dividends to stockholders.
Cash paid for dividends is sometimes added to

Debt ratio: percentage of company funding that is borrowed
Current ratio: indication of a company’s ability to pay its short-term debts
Return on sales: pennies in profit on each dollar of sales
Asset turnover: measure of efficiency; number of sales dollars generated by each dollar of assets
Return on equity: pennies in profit for each dollar invested by stockholders
Price-earnings ratio: number of dollars an investor must pay to “buy” the future rights to each dollar of current earnings
Six of the most commonly used ratios are:

traditional analysis models are based on the balance sheet and the income statement.
Cash flow ratios are frequently overlooked because

statements are not comparable or if statements exclude significant information.
Analysis of financial statements can be misleading if

financial statements don’t contain all the relevant information;
financial statements sometimes can’t be properly compared among companies because of differences in classification, industry mix, and accounting methods;
most sets of financial statements will not reveal a smoking gun that, if fixed, will solve all of a company’s problems; and
focusing on historical financial statement data may cause us to overlook important current information.
We must be careful not to base a decision solely on an analysis of financial statement numbers because

financial statements don’t contain all the relevant information;
financial statements sometimes can’t be properly compared among companies because of differences in classification, industry mix, and accounting methods;
most sets of financial statements will not reveal a smoking gun that, if fixed, will solve all of a company’s problems; and
focusing on historical financial statement data may cause us to overlook important current information.
We must be careful not to base a decision solely on an analysis of financial statement numbers because:

being able to know months ahead of time that a cash need will arise.
The advantage of forecasting cash flows is

To provide accurate accounting records and financial statements containing reliable data for business decisions.
To safeguard assets and records. Most companies think of their assets as including their financial assets (such as cash or property), their employees, their confidential information, and their reputation and image.
To effectively and efficiently run their operations, without duplication of effort or waste.
To follow management policies.
To comply with the Foreign Corrupt Practices and Sarbanes-Oxley acts, which require companies to maintain proper record-keeping systems and controls.
Most companies have the following five concerns in mind when they are designing internal controls:

passed the Sarbanes-Oxley Act (known as the Corporate Responsibility Act) in 2002.
Following the rash of reported financial statement frauds in 2001 and 2002, Congress

state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting;
contain an assessment of the effectiveness of the internal control structure by management;
contain an independent assessment of the reliability of internal controls by the independent auditor.
The Sarbanes-Oxley Act requires, among other things, that every company’s annual report contain an “internal control report,” which must

prepare and sign a statement to accompany their financial statements that certifies the “appropriateness of the financial statements and disclosures contained in the report.”
The Sarbanes-Oxley Act also requires that the CEO and CFO of every public company

The control environment
Risk assessment
Control activities
Information and communication
Monitoring
A company’s internal control structure can be divided into five basic categories:

(preventative)

Segregation of duties
Proper procedures for authorizations
Physical control over assets and records
(detective)
Adequate documents and records
Independent checks on performance
Control activities fall into five categories:
Authorization.
Record keeping.
Custody of assets.
Three functions should be performed by separate departments or by different people whenever possible:
It is easily interpreted and understood.
It has been designed with all possible uses in mind.
It has been pre-numbered for easy identification and tracking.
It is formatted so that it can be handled quickly and efficiently.
A well-designed document has several characteristics:
Meet internal targets
Meet external expectations
Income smoothing
Window dressing for an IPO or a loan
Some of the reasons that managers may manipulate reported earnings are as follows:

(1) modifying operating decisions, such as delaying expenditures for research and development, and
(2) modifying accounting, such as massaging the timing or judgments involved in making accounting estimates.
Most financial statement observers believe the first type of earnings management is more appropriate than the second.
There are two common ways to engage in earnings management:

the establishment of independent oversight of auditors,
constraints on auditors, and
constraints on company management.
The major effects of the Sarbanes-Oxley Act can be divided into three categories:
Register all public accounting firms that provide audits for public companies.
Establish standards relating to the preparation of audit reports for public companies.
Conduct inspections (reviews) of accounting firms.
Conduct investigations and disciplinary proceedings and impose appropriate sanctions on public accounting firms whose performance is inadequate.
Enforce compliance with the Sarbanes-Oxley Act.
The PCAOB is required to do the following:
Accounting firms that audit public companies are prohibited from providing several nonaudit services to their clients
Audit partners on engagements be rotated off the audit every five years
Auditors report to and be retained by the audit committee rather than the CFO or other members of the company’s management
To ensure that external auditors remain independent, Sarbanes-Oxley requires the following:
The CEO and CFO of each public company must prepare a statement to accompany the audit report to certify to the appropriateness of the financial statements and disclosures. Management must also provide an assessment of internal controls in each annual report.
All public companies must develop and enforce an officer code of ethics.
Loans to executive officers and directors are prohibited.
Management must support a much stronger board and audit committee in each public company. The audit committee is a subset of the board of directors and must consist only of individuals who are not part of the management team of the company.
Sarbanes-Oxley requires management to do the following:
interviews,
observation,
sampling,
confirmation, and
analytical procedures.
Auditors gain confidence in the quality of the reporting process using several different processes:

all public companies, and often by creditors and other users.
Independent financial statement audits are required for

Registration statements.
Form 10-K.
Form 10-Q.
Of the many reports required by the SEC, the following have the most direct impact on financial reporting:

Registration statements
These include various forms that must be filed and approved before a company can sell securities through the securities exchanges.

Form 10-K
This report must be filed annually for all publicly held companies. The report contains extensive financial information, including audited financial statements by independent CPAs. The 10-K also requires additional disclosure beyond that typically provided in the audited financial statements, like the executive compensation of top management and the details of property, plant, and equipment transactions.

Form 10-Q
This report must be filed quarterly for all publicly held companies. It contains certain financial information and requires a CPA’s involvement.

file detailed periodic reports with the SEC.
The Securities Exchange Act of 1934 requires all public companies to

submit a registration statement to the SEC for approval.
The Securities Act of 1933 requires most companies planning to issue new debt or stock securities to the public to

Careful timing of transactions
Changing accounting methods or estimates with full disclosure
Changing accounting methods or estimates without adequate disclosure
Non-GAAP accounting
Fictitious transactions
Techniques of earnings management
Requiring independent audits
Reviewing financial statements itself
Sanctioning firms that violate its standards
The SEC adds credibility to financial statements by
Unique competitive tool
Both financial and nonfinancial data
Usually kept secret within the company
Used for internal planning, control, and evaluation
Management Accounting
Is legislated and governed by regulatory agencies and professional institutions
Uniform across companies (generally accepted accounting principles)
Restricted to financial data
Data often made public
Used primarily by investors and creditors in deciding whether to provide capital to the company
Financial Accounting
Strategic planning
Capital budgeting
Long-run planning includes:
Production and process prioritizing
Operational budgeting (profit planning)
Short-run planning includes:

determining how a company’s sales impact profits.
The basic objective of C-V-P analysis is

breakeven analysis.
C-V-P analysis is often referred to as

categorize costs as either fixed or variable.
To use C-V-P analysis successfully, a manager must

salaries of the president and controller, depreciation or rent on office buildings, taxes on assets used in administration, and other office expenditures such as postage, supplies, and utilities.
Examples of administrative costs are

the products or services with which they are associated are sold.
Product costs are expensed only when

as an expense immediately in the period in which they are incurred.
All period costs are reported

Direct materials
Direct labor
Manufacturing overhead
To help management analyze the manufacturing cost of its products, product costs are divided into three components:

fixed or variable, although they are nearly always fixed.
Indirect costs can be either

a business segment such as a division or product line can be evaluated on the basis of only those costs directly traceable or chargeable to it.
Costs are designated as either direct or indirect so that

the controller.
In most organizations, professionals responsible for accounting systems and other critical decision-support data report to

a vice president of finance or perhaps the chief finance officer (CFO). This individual, in turn, reports to the organization’s president or chief executive officer (CEO).
The controller usually reports to

the leading professional organization in North America devoted exclusively to management accounting.
The Institute of Management Accountants (IMA) is

Be competent in their profession
Not disclose confidential information
Act with both actual and apparent integrity in all situations
Maintain objectivity when communicating information to decision-makers
The IMA notes that its members are ethically required to
Discuss the problem with an immediate supervisor (higher management levels should be approached only when the supervisor is involved).
Confidentially use an objective advisor, if needed, to help clarify the issues.
Resign from the organization and submit an informative report to an appropriate representative of the organization (after exhausting all levels of internal communication).
If confronted with situations that may involve ethical conflicts, the business professional should consider the following courses of action:
Identify overhead cost activities.
Analyze individual overhead costs in terms of those cost activities.
Identify measurable cost drivers.
Assign overhead.
Use the ABC data to make decisions.
The five steps in implementing and using an ABC system are:

Unit—activities that take place each time a unit of product is produced.
Batch—activities that take place in order to support a batch or production run, regardless of the size of the batch.
Product line—activities that take place in order to support a product line, regardless of the number of batches or individual units actually produced.
Facility support—activities necessary to have a production facility in place. However, these activities are not related to any particular line of products or services.
The four general categories of ABC activities are:

Machine maintenance
Machine depreciation
Electricity and other energy costs
Classic examples of unit-level overhead activities are:
Inspections
Machine setups
Movement of and accounting for materials
Examples of batch-level activities are:
Engineering product design
Storage in special warehouses
Managing by a special supervisor of all activities associated with a particular product line
Ordering, purchasing, and receiving materials unique to a particular product line
Examples of product-line activities are:
Property taxes
Factory insurance
Security
Landscaping
General accounting
General factory administration
Examples of facility support activities are:

the cost pool.
The total cost identified as being generated by a specific overhead cost activity is called

common costs that are not assigned to any specific product, division, or product line.
In an ABC system, facility support overhead costs are treated as

fixed costs should not be charged to products or else poor short-term decisions will be made. GPK instead uses a multilevel application of fixed costs to obtain more precise measures of product costs, depending on the timeline being used in the decision process.
The primary focus of GPK is that

cost type accounting, cost center accounting, product cost accounting, and contribution margin accounting.
The four elements used within GPK are

several contribution margins are calculated to obtain detailed information for better profit analyses.
The end result of GPK is that

Reflects economic reality and
Motivates correct behavior.
Two characteristics of a good management accounting measure are that it:

using a simple traditional system based on a single activity measure such as direct labor hours.
Designing and operating an ABC system usually costs more than

use of the improved ABC data results in significantly better decisions.
The increased cost of operating an ABC system pays for itself when

Gather the overhead cost and numerical cost driver data.
Compute the amount of overhead cost per cost driver event.
Use these data to assign overhead to production.
To assign overhead costs to production, the necessary steps are:
Revenues from the sales prices charged for goods and services
Fixed and variable costs
Sales volume
Mix of products
Resulting profits
Key factors involved in C-V-P analysis are:

number of units sold and number of units produced in manufacturing firms,
number of units sold in merchandising firms, and
number of contract hours paid for or billed in service firms.
Some of the most common activity bases used are

when the level of activity increases, total variable costs rise at a directly proportional rate. For example, if the level of activity doubles, the total variable costs will also double. This is called a linear relationship.
Our definition of the variable cost behavior pattern specifies that

decrease as sales or production volume increases.
Fixed costs remain constant regardless of changes in sales or production volume while fixed costs per unit will

the scattergraph (or visual-fit) method.
Probably the simplest method of separating mixed costs into their variable and fixed components is

amount on the cost (vertical) axis at the point where it is intercepted by the regression line.
With the regression line inserted into the scattergraph, the fixed portion of the mixed cost is estimated to be the

the slope of the regression line, which is simply the change in cost divided by the change in activity (sometimes described as “rise over run”).
The variable cost per unit (referred to as the variable cost rate) on the mixed cost scattergraph is equal to

The scattergraph method takes all the data into account. Therefore, this method tends to be more accurate, although it is somewhat subjective and inconsistent because different people might draw the line through the points differently. On the other hand, anyone using the high-low method will consistently get the same results. However, because only two data points are used, the high-low method may not be representative of the costs incurred at all levels of activity.
Difference between the Scattergraph and High-Low Methods

Scattergraph method
High-low method
Two common techniques for analyzing mixed costs are:

plots the regression line through the two most extreme points in a scattergraph.
It is important to realize that the math used in the high-low method essentially

the impact of changes in sales on the contribution margin.
With contribution margin or variable cost ratios, it is easy to analyze

the larger the share of each additional dollar of sales that goes toward covering fixed costs and increasing profit.
The higher the contribution margin ratio,

assessing the risk of selling a new product, setting sales goals and commission rates, deciding on marketing and advertising strategies, and making other similar operating decisions.
Although the goal of business planning is to make a profit, not just to break even, knowing the break-even point can be useful in

Total Fixed Costs/(Sales Price per Unit – Variable Cost per Unit) = Break-Even Sales (in units)
You can also quickly calculate break-even sales in units using the following formula:

(Fixed Costs + Target Income)/Contribution Margin per Unit
The shortcut formula for both the break-even volume and the target income volume in units is:

the variable cost ratio times sales to determine total variable costs.
If you want to use C-V-P analysis to calculate the necessary sales volume in terms of dollars, the per-unit variable cost is not used. Rather, use

Amount of fixed costs
Variable cost rate
Sales price
Sales volume or the number of units sold
Combinations of these variables
By understanding C-V-P analysis, you will be adept at evaluating the effects on profitability of the following common changes in C-V-P variables:

both the total sales revenue and total variable costs.
Remember, any change that affects the number of units sold changes

the vertical (or y-) axis and the volume of units is shown on the horizontal (or x-) axis.
In both a cost-volume-profit (CVP) graph and a profit graph, the dollars (sales revenue or costs) are shown on

Draw the two axes with dollars on the vertical axis and units on the horizontal axis.
Draw the fixed cost line, which is a horizontal line indicating the total amount of fixed cost.
Draw the total cost line. This line starts on the vertical axis at the amount of fixed cost, and the upward slope of the line is equal to the variable cost per unit.
Draw the total revenue line. This line starts at the origin ($0, 0 units), and the upward slope of the line is equal to the selling price per unit.
Label the break-even point. This is the point where the total revenue and total cost lines intersect.
A CVP graph is constructed as follows:
Draw the two axes with dollars on the vertical axis and units on the horizontal axis.
Place a point on the vertical axis equal to the loss the company will experience if it has no sales. This loss is equal to the amount of fixed cost.
Place a second point, this time on the horizontal axis, indicating the number of units the company needs to sell to break even.
Draw a line passing through these two points. This is the profit line.
A profit graph is constructed as follows:

a company starts changing the mix of products that it sells.
C-V-P analysis must be adjusted when

the sale of products with higher contribution margin ratios.
Other things being equal, to maximize profits, management should put greater emphasis on

use debt, rather than equity, to raise funds for the company.
In general, the financial leverage (and risk) of a company increases as management chooses to

fixed cost, rather than variable cost, to create or obtain the product for sale to the marketplace.
The operating leverage (and risk) of a company increases as management chooses to emphasize

the potential for large gains in income as sales go up.
In the case of operating leverage, the risk of loss is balanced by

below the break-even point, but the more money it makes if sales are above the break-even point.
The higher the operating leverage, the more money a company loses if sales are

high operating leverage / low operating leverage
High fixed costs (and low variable costs) indicate ; low fixed costs (and high variable costs) indicate .

Notes for users

Know how events (like hiring employees/buying equip) affect the bal sheet/acctg equation
Know the Sox reqs for auditing firms/mgmt & IFRS/GAAP/IMA/etc
Pay close attention to the wording on calculation questions so you know what they’re asking for
The fonts were messed up on my OA plus there were grammar/spelling errors that made it look more like a garbled buzzfeed quiz than a masters-level exam, made some of the q’s a little difficult to read
Know what goes into product costs vs period costs
Know how accrual accounting applies those costs
Know how to calc ABC costs/manuf overhead
Know what’s on bal sheet/inc stmt/cash flows inside and out, that stuff is like half the assessment
Know order of liquidity on bal sheet (like cash, inv, prepaid, etc)
Know diff bt ops/inv/fin activities on cash flow stmt
Know diffs bt mgmt acctg and fin acctg
I also studied lola_hana & zhanleon’s quizlets, they were helpful as well. Watched the cohorts on 2x. Read/skimmed the text. Watched a couple of the embedded videos in the sections I didn’t do as well on the pre-a. Spent about a week in the class, scored 97% on the OA.
Know internal controls/procedures

TERM
Easy if you had accounting
DEFINITION
at Wgu same material, more in depth
LOCATION
Image: Easy if you had accounting

TERM
Know the basic fundamentals
DEFINITION
like the accounting equation and all that
LOCATION
Image: Know the basic fundamentals

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