6 - The Accounting System: Concepts and Applications

Question 1

Why do managers, investors, creditors, and others need information about the operations of a business?

Answer 1

Internal and external users need information about a business’s operations to evaluate alternatives.

For instance, a manager needs this information to decide which alternative best helps the business meet its goals of remaining solvent and earning a satisfactory profit.

A banker also needs this information to decide the conditions for granting a loan.

Question 2

What are the basic concepts and terms used in accounting?

Answer 2

1. Entity concept
2. Transactions
3. Source documents
4. Monetary unit concept
5. Historical cost concept

Question 3

What is the entity concept?

Answer 3

Separation of accounting records of a business from the records of the business’s owner or owners.

Question 4

What are transactions?

Answer 4

Exchange of property or service by a business with another entity.

Question 5

What are source documents?

Answer 5

Business records that are used as evidence that a transaction has occurred.

Question 6

What is the monetary unit concept?

Answer 6

The concept that transactions are to be recorded in terms of money or currency.

Question 7

What is the historical cost concept?

Answer 7

The concept that a business records its transactions based on the dollars exchanged at the time the transaction occurred.

Question 8

What is prepaid insurance?

Answer 8

The cost paid for the right to insurance protection.

Question 9

What are creditors?

Answer 9

External parties to whom a business owes debts

Question 10

What are wages and salaries payable?

Answer 10

Amounts owed to employees for work they have done

Question 11

What are loans payable?

Answer 11

Amounts owing to financial institutions for money lent to the business.

Question 12

What are assets?

Answer 12

Assets are a business’s economic resources that will provide future benefits to the business.

Question 13

What are liabilities?

Answer 13

Liabilities are the economic obligations (debts) of a business.

Question 14

What is partner’s equity?

Answer 14

The partner’s current investment in the assets of the business.

Question 15

What is residual equity?

Answer 15

The term is used to refer to owner’s equity because creditors have the first legal claim to a business’s assets.

Question 16

What is owner’s equity?

Answer 16

The owner’s equity of a business is the owner’s current investment in the assets of the business.

Question 17

What is the accounting equation?

Answer 17

Assets = Liabilities + Owner’s Equity

Question 18

What is a balance?

Answer 18

The amount in an account column at the beginning of the period plus the increases and minus the decreases recorded in the column during the period.

Question 19

What is the dual effect of transactions?

Answer 19

A business must make at least two changes in its assets, liabilities, or owner’s equity when it records each transaction.

Question 20

What is the expansion of the accounting equation?

Answer 20

Assets = Liabilities + Owner’s Capital + Net Income

Owner’s Equity = Owner’s Capital + Net Income

Net Income = Revenues - Expenses

Question 21

What are revenues?

Answer 21

Prices charged to a business’s customers for the goods or services the business provides to them.

Question 22

What are expenses?

Answer 22

Costs a business incurs to provide goods or services to its customers during an accounting period.

Question 23

What is the accounting period?

Answer 23

Timespan for which a business reports its revenues and expenses

Question 24

What is the earning process?

Answer 24

Purchasing (or producing) inventory, selling the inventory (or services), delivering the inventory (or services), and collecting and paying cash.

Question 25

What is the recording process?

Answer 25

A business does this during the accounting period in which the revenues are earned and are collectable (or collected).

Question 26

What is the matching principle?

Answer 26

To determine its net income for an accounting period, a business computes and deducts the total expenses from the total revenues earned during the period.

Question 27

What is going concern?

Answer 27

An assumption that an entity is able to continue as a viable entity for the foreseeable future.

Question 28

What is accrual accounting?

Answer 28

Recording revenues and related expense transactions in the same accounting period that goods or services are provided, regardless of when cash is received or paid.

Question 29

What is a withdrawal?

Answer 29

A payment from the business to the owner

Question 30

What are end-of-period adjustments?

Answer 30

Increases or decreases to account balances at the end of the period to reflect the costs of providing goods or services that are not supported by source documents.

Question 31

What is depreciation?

Answer 31

The systematic periodic transfer of the cost of a fixed asset to an expense account during its expected useful life

Question 32

What is the relationship between the income and balance sheet?

Answer 32

There is a connection between the balance sheet and income statement when double-entry accounting is used.

In essence, increases in revenue and gains as reported on the income statement cause stockholders’ equity to increase on the balance sheet. In addition, increases in expenses and losses as reported on the income statement cause stockholders’ equity to decrease on the income statement.

In addition, the write-down of an asset on the balance sheet causes a loss to appear on the income statement.

Assets = Liabilities + Owner’s Capital + Net Income

Net Income = Revenues - Expenses