Accounting Cycle 5-7

Question 1

What is the purpose of account adjustments?

Answer 1

Make sure revenues and expenses get recorded in the proper time period

Question 2

What is “depreciation”?

Answer 2

The process whereby companies systematically allocate the cost of their tangible operating assets (other than land) as an expense in each period in which the asset is used

Question 3

What are “deferrals”?

Answer 3

A category of adjustments for time differences in step 5 of the accounting cycle - adjust the accounts.

Question 4

What are the steps to close the accounts?

Answer 4

Close revenues (and gains) to Retained Earnings
Close expenses (and losses) to Retained Earnings
Close dividends declared to Retained Earnings

Question 5

What is “accrual-basis accounting”?

Answer 5

A method of accounting in which revenues are generally recorded when earned (rather than when cash is received). Same for expenses.

Question 6

What are “deferred (prepaid) expenses”?

Answer 6

Assets arising from the payment of cash that have not been used or consumed by the end of the period

Question 7

What form of accounting is required by GAAP?

Answer 7

Based on revenue/expense recognition principles, and the time-period assumption, accrual-basis accounting is required for corporations.

Question 8

What are “temporary accounts”?

Answer 8

the accounts of revenue, expense, and dividend items that are used to collect the activities of only one period

revenues, gains, expenses, losses, dividends declared

Question 9

What is a three-step procedure for making adjusting journal entries?

Answer 9

1) Identify pairs of income statement and balance sheet accounts that require adjustment
2) Calculate the amount of the adjustment based on the amount of revenue that was earned or the among of expense incurred during the time period
3) Record the adjusting journal entry

Cash will never be affected by adjustments!

Question 10

What are “accrued revenues”?

Answer 10

Assets resulting from revenues that have been earned but for which no cash has yet been received.

Question 11

What is an “adjusted trial balance”?

Answer 11

It’s the start of step 6, preparing financial statements, when the trial balance is updated to reflect the changes after adjusting the accounts

Question 12

What is “cash-basis accounting”?

Answer 12

A method of accounting in which revenue is recorded when cash is received, regardless of when it is actually earned. Same for expenses.

Cash-basis accounting does not tie recognition of revenues and expenses to the actual business activity but rather to the exchange of cash.

Question 13

What are “contra-accounts”?

Answer 13

Accounts that have a balance that is opposite the balance in its related account.
For long-lived assets the contra-account is called “accumulated depreciation”

Question 14

What are “deferred (unearned) revenues”?

Answer 14

Liabilities arising from the receipt of cash for which revenue has not yet been earned.

Question 15

How does the revenue recognition principle work?

Answer 15

A seller satisfies a performance obligation by transferring control of a promised good or service to a customer.

May be recognized at “a point in time” (purchase of a grill at lowes), or “over time” (fedex delivering a package).

Question 16

What are two limitations of cash-basis accounting?

Answer 16

1) It does not link recognition of revenues and expenses to the actual business activity but rather the exchange of cash.
2) May not reflect all of the assets and liabilities of a company at a particular date.

Question 17

What are “accruals”?

Answer 17

A category of adjustments for time differences in step 5 of the accounting cycle - adjust the accounts.

Question 18

What is the “matching principle”?

Answer 18

Another name for the expense-recognition principle in the GAAP. States that expenses are recorded and reported in the same period as the revenue it helped to generate.

Question 19

What are “permanent accounts”?

Answer 19

accounts of asset, liability, and stockholders’ equity items whose balances are carried forward from the current accounting period to future accounting periods

Question 20

What order should financial statements be prepared?

Answer 20

1) The income statement
2) Net income and dividends declared are used to prepare the retained earnings statement
3) The balance sheet is prepared using the ending balance of retained earnings from the retained earnings statement

Question 21

What are “accrued expenses”?

Answer 21

Liabilities arising from expenses that have been incurred but not yet paid in cash.