CLEP® Financial Accounting Book + Online

PREFACE

You can do it!

You can learn enough from this book to pass the CLEP Financial Accounting exam.

This book contains all the information you would find in the first college semester of financial accounting. If you learn it well, you could move on to the second semester (usually managerial accounting) or on to intermediate financial accounting. Or . . . you can pass financial accounting, breathe a sigh of relief and call it the end of your accounting career.

Learning accounting is like learning to play the piano. Practice makes perfect. No matter what your background, grasping accounting from a book takes discipline. But this book is designed for you even if you have a special advantage such as:

•  You studied accounting in high school, or

•  You have used some accounting in your job, or

•  You took a college financial accounting course and, unfortunately, flunked.

What you need now is a tool to help you store the necessary information in your brain so you can move on in your career. This book is that tool.

For more than twenty-five years, I have helped students like you pass tests like the CLEP Financial Accounting exam. I have encouraged and prodded hundreds of students who at first cried, I can’t! but who in the end cheered, "I did!"

If you had the courage to pick up this book, I believe you are another successful CLEP candidate in the making.

My best wishes go with you.

Respectfully,     

Donald P. Balla  

CHAPTER 1

Passing the CLEP Financial Accounting Exam

CHAPTER 1

PASSING THE CLEP FINANCIAL ACCOUNTING EXAM

Congratulations! You’re joining the millions of people who have discovered the value and educational advantage offered by the College Board’s College-Level Examination Program, or CLEP. This test prep covers everything you need to know about the CLEP Financial Accounting exam, and will help you earn the college credit you deserve while reducing your tuition costs.

GETTING STARTED

There are many different ways to prepare for a CLEP exam. What’s best for you depends on how much time you have to study and how comfortable you are with the subject matter. To score your highest, you need a system that can be customized to fit you: your schedule, your learning style, and your current level of knowledge. This book, and the online tools in the CLEP package, allow you to create a personalized study plan through three simple steps: assessment of your knowledge, targeted review of exam content, and reinforcement in the areas where you need the most help.

$1.99 unlocks the CLEP online tools at www.rea.com/studycenter

Let’s get started and see how this system works.

THE REA STUDY CENTER

The best way to personalize your study plan and focus on your weaknesses is to get feedback on what you know and what you don’t know. At the online REA Study Center, you can access two types of assessment: a diagnostic exam and full-length practice exams. Each of these tools provides true-to-format questions and delivers a detailed score report that follows the topics set by the College Board.

Diagnostic Exam

Before you begin your review with the book, take the online diagnostic exam. Use your score report to help evaluate your overall understanding of the subject, so you can focus your study on the topics where you need the most review.

Full-Length Practice Exams

These practice tests give you the most complete picture of your strengths and weaknesses. After you’ve finished reviewing with the book, test what you’ve learned by taking the first of the two online practice exams. Review your score report, then go back and study any topics you missed. Take the final practice test to ensure you have mastered the material and are ready for test day.

$1.99 unlocks the CLEP online tools at www.rea.com/studycenter

If you’re studying and don’t have Internet access, you can take the printed tests in the book. These are the same practice tests offered at the REA Study Center, but without the added benefits of timed testing conditions and diagnostic score reports. Because the actual exam is computer-based, we recommend you take at least one practice test online to simulate test-day conditions.

AN OVERVIEW OF THE EXAM

The CLEP Financial Accounting exam covers the material one would find in a college-level Financial Accounting class. The exam assesses the student’s knowledge and mastery of the skills and concepts found in an entry-level financial accounting course, including familiarity with accounting concepts and terminology, understanding and analyzing accounting data, and applying accounting techniques to problem-solving situations.

The exam consists of 75 multiple-choice questions, each with five possible answer choices, to be answered in 90 minutes.

The approximate breakdown of topics is as follows:

ALL ABOUT THE CLEP EXAMS

What is the CLEP?

CLEP is the most widely accepted credit-by-examination program in North America. CLEP exams are now available in 33 subjects and test the material commonly required in an introductory-level college course. Examinees can earn from three to twelve credits at more than 2,900 colleges and universities in the U.S. and Canada. For a complete list of the CLEP subject examinations offered, visit the College Board website: www.collegeboard.org/clep.

Who takes CLEP exams?

CLEP exams are typically taken by people who have acquired knowledge outside the classroom and who wish to bypass certain college courses and earn college credit. The CLEP program is designed to reward examinees for learning—no matter where or how that knowledge was acquired.

Although most CLEP examinees are adults returning to college, many graduating high school seniors, enrolled college students, military personnel, veterans, and international students take CLEP exams to earn college credit or to demonstrate their ability to perform at the college level. There are no prerequisites, such as age or educational status, for taking CLEP examinations. However, because policies on granting credits vary among colleges, you should contact the particular institution from which you wish to receive CLEP credit.

Who administers the exam?

CLEP exams are developed by the College Board, administered by Educational Testing Service (ETS), and involve the assistance of educators from throughout the United States. The test development process is designed and implemented to ensure that the content and difficulty level of the test are appropriate.

When and where is the exam given?

CLEP exams are administered year-round at more than 1,200 test centers in the United States and can be arranged for candidates abroad on request. To find the test center nearest you and to register for the exam, contact the CLEP Program:

CLEP Services

P.O. Box 6600

Princeton, NJ 08541-6600

Phone: (800) 257-9558 (8 A.M. to 6 P.M. ET)

Fax: (609)771-7088

Website: www.collegeboard.org/clep

OPTIONS FOR MILITARY PERSONNEL AND VETERANS

CLEP exams are available free of charge to eligible military personnel and eligible civilian employees. All the CLEP exams are available at test centers on college campuses and military bases. Contact your Educational Services Officer or Navy College Education Specialist for more information. Visit the DANTES or College Board websites for details about CLEP opportunities for military personnel.

Eligible U.S. veterans can claim reimbursement for CLEP exams and administration fees pursuant to provisions of the Veterans Benefits Improvement Act of 2004. For details on eligibility and submitting a claim for reimbursement, visit the U.S. Department of Veterans Affairs website at www.gibill.va.gov/pamphlets/testing.htm.

CLEP can be used in conjunction with the Post-9/11 GI Bill, which applies to veterans returning from the Iraq and Afghanistan theaters of operation. Because the GI Bill provides tuition for up to 36 months, earning college credits with CLEP exams expedites academic progress and degree completion within the funded timeframe.

SSD ACCOMMODATIONS FOR CANDIDATES WITH DISABILITIES

Many test candidates qualify for extra time to take the CLEP exams, but you must make these arrangements in advance. For information, contact:

College Board Services for Students with Disabilities

P.O. Box 6226

Princeton, NJ 08541-6226

Phone: (609) 771-7137 (Monday through Friday, 8 A.M. to 6 P.M. ET)

TTY: (609) 882-4118

Fax: (609)771-7944

E-mail: [email protected]

6-WEEK STUDY PLAN_

Although our study plan is designed to be used in the six weeks before your exam, it can be condensed to three weeks by combining each two-week period into one.

Be sure to set aside enough time—at least two hours each day—to study. The more time you spend studying, the more prepared and relaxed you will feel on the day of the exam.

$1.99 unlocks the CLEP online tools at www.rea.com/studycenter

TEST-TAKING TIPS

Know the format of the test. CLEP computer-based tests are fixed-length tests. This makes them similar to the paper-and-pencil type of exam because you have the flexibility to go back and review your work in each section.

Learn the test structure, the time allotted for each section of the test, and the directions for each section. By learning this, you will know what is expected of you on test day, and you’ll relieve your test anxiety.

Read all the questions—completely. Make sure you understand each question before looking for the right answer. Reread the question if it doesn’t make sense.

Annotate the questions. Highlighting the key words in the questions will help you find the right answer choice.

Read all of the answers to a question. Just because you think you found the correct response right away, do not assume that it’s the best answer. The last answer choice might be the correct answer.

Work quickly and steadily. You will have 90 minutes to answer 75 questions, so work quickly and steadily. Taking the timed practice tests online will help you learn how to budget your time.

Use the process of elimination. Stumped by a question? Don’t make a random guess. Eliminate as many of the answer choices as possible. By eliminating just two answer choices, you give yourself a better chance of getting the item correct, since there will only be three choices left from which to make your guess. Remember, your score is based only on the number of questions you answer correctly.

Don’t waste time! Don’t spend too much time on any one question. Remember, your time is limited and pacing yourself is very important. Work on the easier questions first. Skip the difficult questions and go back to them if you have the time.

Look for clues to answers in other questions. If you skip a question you don’t know the answer to, you might find a clue to the answer elsewhere on the test.

Acquaint yourself with the computer screen. Familiarize yourself with the CLEP computer screen beforehand by logging on to the College Board website. Waiting until test day to see what it looks like in the pretest tutorial risks injecting needless anxiety into your testing experience. Also, familiarizing yourself with the directions and format of the exam will save you valuable time on the day of the actual test.

Be sure that your answer registers before you go to the next item. Look at the screen to see that your mouse-click causes the pointer to darken the proper oval. If your answer doesn’t register, you won’t get credit for that question.

THE DAY OF THE EXAM_

On test day, you should wake up early (after a good night’s rest, of course) and have breakfast. Dress comfortably, so you are not distracted by being too hot or too cold while taking the test. (Note that hoodies are not allowed.) Arrive at the test center early. This will allow you to collect your thoughts and relax before the test, and it will also spare you the anxiety that comes with being late. As an added incentive, keep in mind that no one will be allowed into the test session after the test has begun.

Before you leave for the test center, make sure you have your admission form and another form of identification, which must contain a recent photograph, your name, and signature (i.e., driver’s license, student identification card, or current alien registration card). You will not be admitted to the test center if you do not have proper identification.

You may wear a watch to the test center. However, you may not wear one that makes noise, because it may disturb the other test-takers. No cell phones, dictionaries, textbooks, notebooks, briefcases, or packages will be permitted, and drinking, smoking, and eating are prohibited.

Good luck on the CLEP Financial Accounting exam!

CHAPTER 2

Getting Started

CHAPTER 2

GETTING STARTED: Discovering the Balance Sheet

Welcome to financial accounting. Financial accounting is the skill of producing financial statements from business transactions.

In this chapter you will learn:

•  How to analyze business start-up transactions.

•  How to present those transactions on a balance sheet.

•  How to analyze the balance sheet.

•  About the accounting cycle and the fiscal year.

2.1.  BALLOON PARTY, LAUREN’S NEW BUSINESS

Lauren’s business idea is to sell balloons at all the county fairs in the state. A supplier will provide balloons at prices from 2¢ to 25¢ each. A large tank of helium costs $500 initially and only $50 to fill. Cousin Lou agrees to sell his $2,000 Pontiac to Lauren for $100 down and 19 monthly payments at 12% interest. Lauren hands Lou a $100 bill.

Lauren transfers $800 from her savings account into a new checking account called Balloon Party. She writes two checks. One for $550 goes to buy a filled helium tank. Another check for $70 buys balloons.

2.2.  

LAUREN’S FIRST ACCOUNTING

Accounting helps Lauren record her business transactions.

ACCOUNTING PRINCIPLE

Every transaction gets recorded twice: (1) where the money comes from, and (2) where it goes. This is called double entry accounting.

Table 2-1 Analyzing Balance Sheet Transactions

The $500 that Lauren paid to buy the canister is not gone. It has simply transformed from cash into another useful item. The same happened with the car and the supplies of balloons and helium. The money was not expensed (gone forever) but capitalized—that is, changed into capital, another asset that helps you make money. In the next chapter, you will learn how to record a transaction in which the owner spends money and has nothing to show for it. For now, Lauren has not lost any money, as this analysis shows.

Where did the money go?

or

Here’s what the business has.

Where did the money come from?

or

Here’s who has a claim on what the business has.

This is Lauren’s first accounting report—a balance sheet. What she has ($2,800) balances the claims on what she has (also $2,800).

QUESTION 1.  It must balance. Why? (The answers to these questions are always at the end of each chapter.)

When Where did it go? equals Where did it come from?, Lauren has balanced books.

2.3.  THE BALANCE SHEET INTRODUCED

Let’s rewrite the balance sheet using some standard terminology.

CLEP CLUE

The CLEP test continually tests your knowledge of terminology. Smart idea: make a flash card for all words you do not know.

Figure 2-1 Balloon Party’s Balance Sheet: 4/14/20×1

The heading. All financial statements have a three-line heading. The first line is the business name. The second is the name of the report. The third is the date or period of time. Balance sheets are always for a -specific date. (In this book 20x1 represents the first year of Lauren’s business, although in real life, of course, you would use the number of the actual year.)

Note that Lauren’s name appears nowhere on the balance sheet. Lauren must not mix her personal financial information with the business information.

ACCOUNTING PRINCIPLE

Financial statements report on the business entity, not the owner’s personal wealth.

Assets is now the official name for Here’s what your business has. Assets are economic resources that the business plans to use in the future to make money.

Financial reports are primarily for the owner and should report assets the way the owner wants them. However, other people also use these financial statements, so you will be learning the standard names of common assets.

Liabilities is now the official name for What I owe other people. Lauren owes the money to creditors. Loan payable is the common term for reporting a loan. Lauren added —Cousin Lou to distinguish this loan from future loans.

CLEP CLUE

Every time you see the word payable, the CLEP exam is talking about a liability.

Creditors do not own any part of the business assets. However, they do have a claim on the assets. In Lauren’s case, Lou does not own the car. But if Balloon Party does not make its payments, Lou can ask a court to let him take the car back.

Owner’s equity is the official name for the owner’s claim on the assets in the business.

The total line for Here’s who has a claim on what your business has, is now called total liabilities plus owner’s equity. This number must equal total assets because all the assets that creditors do not claim belong to Lauren. Therefore, the fundamental accounting equation is:

QUESTION 2:  If Lauren has $2,800 of assets and owes $1,000, how much is her equity?

EXERCISE

The following numbers were taken from Lauren’s books. Place them in the proper place on the balance sheet and give the numbers the proper names. Use today’s date in the heading. Figure 2-1 shows the correct answer.

2.4.  ANALYZING THE BALANCE SHEET

Lauren analyzed her balance sheet and learned some interesting facts, as shown in Table 2.2.

Table 2.2 Analyzing the Balance Sheet: 4/14/20x1

Lauren’s debt ratio measures the portion of her business that creditors claim. Balloon Party’s 68% debt ratio is high. It is more than twice Lauren’s 32% equity ratio, which measures the owner’s claim on the business assets. The higher the debt ratio, the higher the risk for the business.

QUESTION 3.  When you add the debt ratio and the equity ratio, what number do you always get?

CLEP CLUE

If given one of these ratios on the CLEP test, subtract that number from 100% to quickly find the other.

Example: If the debt ratio is 55%, the equity ratio is 100%-55% = 45%.

Current liabilities are those debts that must be paid in the coming 12 months, or longer if a business has a natural operating cycle (see Section 2.5) that is longer than one year. The most common current liabilities are invoices the business receives for goods and services it has purchased but not yet paid. Although Balloon Party has no bills like that, it does owe Cousin Lou $1,900. Of that amount, $1,200 is due within one year (12 payments of $100/month).

Current assets are those that the business can use to pay current liabilities. Cash, of course, is easy to use to pay bills. The company’s inventory of helium and balloons will probably be sold in the coming year and turned into cash. The easier it is to turn an asset into cash, the more liquid the asset is. Current assets are the most liquid assets of the business. Since the business will probably not change the canister and the car into cash in the coming year, they are not current assets.

The current ratio measures a company’s ability to pay coming bills. A healthy ratio is anything over 100%. That would mean the company already has more current assets than current liabilities. In Balloon Party’s case, its ratio of 25% is a warning sign. Unless Balloon Party makes some money this summer,