Chapter 3

Question 1

Generalizing:

Answer 1

(a) accounting measurements tend to be based on historical cost determined by reference to an exchange transaction with another party (e.g., a purchase)
(b) income is”revenues” minus “expenses” as determined by reference to those transactions

Question 2

Revenue

Answer 2

Inflows and enhancements from delivery of goods and services that constitute central ongoing operations

Question 3

Expense

Answer 3

Outflows and obligations arising from the production of goods and services that constitute central ongoing operations

Question 4

Gain/Loss

Answer 4

Like revenues/expenses, but from peripheral transactions or events

Question 5

Income =

Answer 5

Revenues + Gains - Expenses - Losses

Question 6

periodicity assumption

Answer 6

business activity can be divided into measurement intervals, such as months, quarters, and years.
-why- events may take a long time to close-investors nee to know how business is doing

Question 7

fiscal year

Answer 7

running from any point of beginning to one year later

follow natural business cycles

Question 8

accrual-basis

Answer 8

The accounting process whereby revenues are measured and recorded as earned, while expenses are recorded as incurred

Question 9

Revenue recognition

Answer 9

normally occurs at the time services are rendered or when goods are sold and delivered.
The conditions for revenue recognition are
(a) an exchange transaction, and
(b) the earnings process being complete.

product must be manufactured and delivered.

Question 10

Additional Guidelines for Revenue Recognition

Answer 10

persuasive evidence of an arrangement, delivery has occurred (or services rendered), the seller’s price is fixed or determinable, and collectability is reasonably assured.

Question 11

Expense recognition will typically follow one of three approaches

Answer 11

• Associating cause and effect:
• Systematic and rational allocation
• Immediate recognition

Question 12

Associating cause and effect

Answer 12

Many costs are linked to the revenue they help produce. For example, a sales commission owed to an employee is based on the amount of a sale. Therefore, commission expense should be recorded in the same accounting period as the sale. Likewise, the cost of inventory delivered to a customer should be expensed when the sale is recognized. This is what is meant by associating cause and effect, and is also referred to as the matching principle.

Question 13

Systematic and rational allocation

Answer 13

In the absence of a clear link between a cost and revenue item, other expense recognition schemes must be employed. Some costs benefit many periods. Stated differently, these costs expire over time. For example, a truck may last many years; determining how much cost is attributable to a particular year is difficult. In such cases, accountants may use a systematic and rational allocation scheme to spread a portion of the total cost to each period of use (in the case of a truck, through a process known as depreciation).

Question 14

•Immediate recognition

Answer 14

some costs cannot be linked to any production of revenue, and do not benefit future periods either. These costs are recognized immediately. An example would be severance pay to a fired employee, which would be expensed when the employee is terminated.

Question 15

adjusting process

Answer 15

To analyze account balances and update them at the end of an accounting period to reflect the correct measure of revenues and expenses

Question 16

Multi Period Items

Answer 16

Prepaid Expenses: insurance, rent, supplies
Depreciation
Unearned revenue

Question 17

Accrued Items

Answer 17

Unrecorded expenses:
Accrued: salaries, interest, rent

Unrecorded Revenues:
Accrued Revenue

Question 18

prepaid expense

Answer 18

supplies that are purchased and stored in advance of actually needing them.
At the time of purchase, such prepaid amounts represent future economic benefits that are acquired in exchange for cash payments. As such, the initial expenditure gives rise to an asset.
As time passes, the asset is diminished. This means that adjustments are needed to reduce the asset account and transfer the consumption of the asset’s cost to an appropriate expense account.

Shown as asset on Balance Sheet and then reduced each month

Income Statement show monthly price

Question 19

contra asset

Answer 19

A contra account is an account that is subtracted from a related account.
As a result, contra accounts have opposite debit/credit rules.
accumulated depreciation is increased with a credit, because the associated asset normally has a debit balance.

Question 20

book value

Answer 20

The asset cost minus accumulated depreciation

Question 21

Unearned revenue

Answer 21

reported as a liability, reflecting the company’s obligation to deliver product in the future. Remember, revenue cannot be recognized in the income statement until the earnings process is complete

Question 22

Accruals

Answer 22

expenses and revenues that gradually accumulate throughout an accounting period

Question 23

cash basis

Answer 23

revenue is recorded when cash is received (no matter when it is earned), and expenses are recognized when paid (no matter when incurred).

Question 24

modified cash-basis

Answer 24

The modified cash-basis results in revenue and expense recognition as cash is received and disbursed, with the exception of large cash outflows for long-lived assets (which are recorded as assets and depreciated over time).

Question 25

Ending supplies

Answer 25

Beg + purchases - used

Question 26

Balance sheet approach

Answer 26

records expired

Question 27

Income statement approach

Answer 27

records unexpired