Ch. 3 Adjusting Accounts for Financial Statements

Question 1

Accruals

Answer 1

Deals with an amount NOT previously recorded in a balance sheet account.

Increases both a balance sheet account and an income statement account.

Two types:

• Accrued revenues
• Accrued expenses

Question 2

Deferrals

Answer 2

Deals with an amount
previously recorded in a
balance sheet account.

Decreases a balance
sheet account and increases an income statement account.

Two types:

• Deferred (unearned) revenue
• Deferred (prepaid) expenses

Question 3

Deferred (unearned) revenue

Answer 3

The process of allocating unearned revenue to revenue.

Amounts received in advance are recorded as liabilities because an obligation exists to provide future services or assets (such as inventory or a refund of cash).

Situations requiring adjusting entries:

• Prepaid property casualty insurance is earned over time
• Subscriptions to newspaper and magazines received in advance are earned

Question 4

Deferred (prepaid) expenses

Answer 4

Amounts paid in advance of using assets that benefit more than one period

Situations requiring adjusting entries:

• Equipment, buildings, or vehicles become used up over time
• Prepayment of advertising, insurance, or rent becomes used up over time
• Supplies are used over time
• Purchased intangibles may be used over time

Question 5

Depreciation

Answer 5

The process of allocating equipment, buildings, and vehicles to expenses

Annual dep exp = asset cost / useful life

Special account used instead of reducing the asset account directly -> Considered a contra asset account

Question 6

Accruing revenues

Answer 6

Amounts earned from providing services or selling products must be recognised in the period earned.

Creates an increase in an asset and an increase in revenues.

Examples requiring adjusting entries:
- Completed services or delivered goods that, for any
number of reasons, have not been billed to customers.
- A company earned interest revenue from the bank on its checking account and had not yet recorded it.

Question 7

Accruing expenses

Answer 7

The process of recognising expenses before the cash is paid.

Examples requiring adjusting entries:

• Utility bill received in the mail for the month just completed.
• Employees earned wages before the month ended, to be paid in the following month.
• Amounts borrowed from a bank have interest that is not due until the note is paid off.
• Income taxes are paid quarterly and the company earned a profit during the first month of the quarter.