Accounting Basics Financial Statements Syllabus

What are current assets?

Assets that a company expects to convert to cash or use up within one year or its operating cycle, whichever is longer (e.g., cash, accounts receivable, inventory, prepaid expenses).

How are current assets typically ordered on a classified balance sheet?

In order of liquidity — how quickly they can be converted to cash — starting with cash, then short-term investments, receivables, inventory, and prepaid expenses.

What are long-term (non-current) assets? Give an example category.

Assets not expected to be converted to cash or consumed within one year, such as long-term investments, property/plant/equipment (PP&E), and intangible assets.

What are current liabilities?

Obligations the company expects to pay within one year or its operating cycle, such as accounts payable, salaries payable, unearned revenue, and the current portion of long-term debt.

What is working capital and how is it calculated?

Working capital measures short-term liquidity: $$\text{Working Capital} = \text{Current Assets} - \text{Current Liabilities}$$

What is the current ratio and its formula?

A liquidity ratio measuring ability to pay short-term obligations: $$\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}$$

What is the difference between the report form and the account form of a balance sheet?

The report form lists assets, then liabilities, then equity vertically (top to bottom). The account form lists assets on the left side and liabilities plus equity on the right side, side by side.

In the account form of the balance sheet, what must be true of the two sides?

The left side (total assets) must equal the right side (total liabilities plus owner's equity), reflecting the accounting equation.

State the fundamental accounting equation reflected in every balance sheet.

$$\text{Assets} = \text{Liabilities} + \text{Owner's Equity}$$

What does 'liquidity order' of accounts mean on a balance sheet?

Listing assets from most liquid to least liquid (and often liabilities from those due soonest to those due latest), so readers can assess short-term solvency.

Which current asset is always listed first, and why?

Cash, because it is the most liquid asset — it is already in the form of money and needs no conversion.

Rank these by liquidity from most to least liquid: inventory, cash, accounts receivable.

Cash (most liquid), then accounts receivable, then inventory (least liquid of the three).

What three activity categories make up the statement of cash flows?

Operating activities, investing activities, and financing activities.

What are operating activities on the statement of cash flows?

Cash flows from the company's principal revenue-producing activities and other transactions that enter into net income (e.g., cash from customers, cash paid to suppliers and employees).

What are investing activities on the statement of cash flows?

Cash flows from purchasing and selling long-term assets and investments, such as buying/selling PP&E or securities and making/collecting loans.

What are financing activities on the statement of cash flows?

Cash flows from transactions with owners and creditors, such as owner investments, drawings/dividends, issuing or repaying debt, and issuing stock.

Under which activity is the purchase of equipment for cash classified?

Investing activities (an outflow, because it is the acquisition of a long-term asset).

Under which activity is an owner's cash investment or a withdrawal (drawing) classified?

Financing activities.

What are the two methods for reporting cash flows from operating activities?

The direct method and the indirect method.

How does the direct method report operating cash flows?

It lists major classes of gross cash receipts and gross cash payments (e.g., cash received from customers, cash paid to suppliers) to arrive at net cash from operations.

How does the indirect method report operating cash flows?

It starts with net income and adjusts it for non-cash items (like depreciation) and changes in current assets and liabilities to reconcile to net cash provided by operating activities.

Do the direct and indirect methods produce the same net cash from operating activities?

Yes. Only the presentation of the operating section differs; the resulting net cash provided (or used) by operating activities is identical under both methods.

Under the indirect method, how is depreciation expense treated and why?

It is added back to net income because depreciation is a non-cash expense that reduced net income but involved no cash outflow.

Under the indirect method, how does an increase in accounts receivable affect the reconciliation from net income?

It is subtracted, because revenue was recorded in net income but the related cash has not yet been collected.

Under the indirect method, how does an increase in accounts payable affect the reconciliation?

It is added, because an expense was recorded in net income but the related cash has not yet been paid, so cash on hand is higher than expenses suggest.

Why can net income differ from net cash flow from operations?

Because net income is measured on the accrual basis (revenues/expenses recorded when earned/incurred), while cash flow reflects actual cash timing; non-cash items and changes in receivables, payables, and inventory create the gap.

Can a company report positive net income yet negative operating cash flow? How?

Yes. For example, large increases in receivables or inventory tie up cash, so the company can be profitable on paper while consuming cash from operations.

What is the purpose of the notes to the financial statements?

To provide additional detail and disclosures that clarify the statements — such as accounting policies, methods used, contingencies, and breakdowns — that cannot be shown on the face of the statements.

Are the notes to the financial statements considered part of the financial statements? What is typically the first note?

Yes, the notes are an integral part of the financial statements. The first note is usually the summary of significant accounting policies (e.g., inventory and depreciation methods).

Describe how the four financial statements connect (articulate) with each other.

Net income from the income statement flows into the statement of owner's equity; the ending equity balance flows onto the balance sheet; and the change in cash on the balance sheet is explained by the statement of cash flows, whose ending cash equals the cash reported on the balance sheet.