CHAPTER 3

Question 1

What is Accrual Accounting?

Answer 1

Records the impact of a business transaction as it occurs. When the business performs a service, makes a sale, or incurs an expense, the accountant records the transaction, even if the business receives or pays no cash.

Question 2

What is Cash-Basis accounting?

Answer 2

This records only cash transactions - cash receipts and cash payments. Cash receipts are treated as revenues, and cash payments are handled as expenses. Required for GAAP

Question 3

What are the two problems with the cash method?

Answer 3

Incomplete balance sheet (Assets are understated) and Incomplete Income Statement (Sales understates a companys revenue)

Question 4

What is the time-period concept?

Answer 4

It ensures the accounting information is reported at regular intervals.

Question 5

What is the revenue principle?

Answer 5

When to record (recognize) revenue and what amount of revenue to record

Question 6

What is the expense recognition principle?

Answer 6

It is the basis for recording expenses. Expenses are the costs of assets used up and of liabilities created in earning revenue. Expenses have no future benefits to the company. The principle includes two steps:
Identify all the expenses incurred during the accounting period and Measures the expenses and recognize them in the same period in which any related revenues are earned.

Question 7

What are the three basic categories for accounting adjustments?

Answer 7

Deferrals (an adjustments for the payment of an item or receipt of cash in advance (prepay)), depreciation (allocates the cost of a plant asset to expense over the asset’s useful life) and accruals (opposite of a deferral, records the expense before paying/collecting cash)

Question 8

What is a prepaid expense? Examples?

Answer 8

It is an expense paid in advance. They are considered assets. Prepaid rent, supplies

Question 9

What are plant assets?

Answer 9

They are long lived tangible asset, such as land, buildings, furniture and equipment.

Question 10

What is the accumulated depreciation account?

Answer 10

The cumulative sum of all depreciation expense from the date of acquiring a plant asset. The balance in the Accumulated Depreciation account increases credit balance. It is a contra asset account, an asset account with a normal credit balance.

Question 11

What is a contra account?

Answer 11

It has two distinguished characteristics. It always has a companion account and its normal balance is opposite that of the companion account.

Question 12

What is the asset’s book value?

Answer 12

The net amount of a plant asset (cost minus accumulated depreciation) is called that asset’s book value.

Question 13

What are accrued expense?

Answer 13

Refers to a liability that arises from an expense that has been incurred but has not yet been paid. Typically the company wait until the end of the period and use an adjusting entry to update each expense (and related liability).

Question 14

What are accrued revenues?

Answer 14

Businesses often earn revenue before they receive the cash. Revenue that has been earned but not yet collected is called an accrued revenue.

Question 15

What are unearned revenues?

Answer 15

Some businesses collect cash from customers before earning the revenue. This creates a liability.

Question 16

What is the summary of the adjusting process?

Answer 16

Two purposes of the adjusting process are to: measure income, and update the balance sheet. Therefore, every adjusting entry affects both of the following: revenues or expense - to measure income and asset or liability - to update the balance sheet.

Question 17

What are the closing the books?

Answer 17

It means the prepare the accounts for the next period’s transactions.

Question 18

What are the closing entries?

Answer 18

It is to set the revenue, expense and dividends balances back to zero at the end of the period.

Question 19

What are the temporary accounts?

Answer 19

Because revenues and expenses relate to a limited period.

Question 20

What are the permanent accounts?

Answer 20

Asset, liability, and stockholders’ equity accounts that are not closed at the end of the period.

Question 21

What is liquidity?

Answer 21

A measure of how quickly an item can be converted to cash.

Question 22

What are current assets?

Answer 22

Are the most liquid assets. They will be converted to cash, sold, or consumed during the next 12 months after the balance sheet date.

Question 23

What are long term assets?

Answer 23

Are all assets not classified as current assets.

Question 24

What are current liabilities?

Answer 24

Debts that must be paid within one year after the balance sheet date or within the operating cycle if it’s longer than a year. Current liabilities are always listed first.

Question 25

What are long-term liabilities?

Answer 25

All liabilities that are not current as classified.

Question 26

What are a classified balance sheet?

Answer 26

It separates current assets from long-term assets and current liabilities from long term liabilities.

Question 27

What are the two Balance-Sheet formats?

Answer 27

Report Format: Lists the assets at the top, followed by the liabilities and stockholders’ equity below.
Account format: Lists assets on the left and liabilities and stockholders’ equity on the right in the same that a T-Account does.

Question 28

What are the two Income Statements formats?

Answer 28

Single-Step Income Statement: Lists all the revenues together under a heading such as Revenues, or Revenues or Gains.
Multistep Income Statement: Reports a number of subtotals to highlight important relationships between revenues and expenses.

Question 29

What is the Net Working Capital?

Answer 29

A computed dollar amount that represents operating liquidity.
Net Working Capital = Total Current Assets - Total Current Liabilities
The result would label the company as liquid.

Question 30

What is the Current Ratio?

Answer 30

Divide total current assets by total current liabilities.

Question 31

What is the debt ratio?

Answer 31

Is the ratio of its total liabilities to its total assets.

Question 32

To help keep debt ratios within normal limits, companies might use one or more of the following strategies?

Answer 32

Increase revenue and decrease costs, thus increasing current assets, net income, and retained earnings without increasing liabilities.
Sell stock, thus increasing cash and stockholders’ equity.
Choose to borrow less money