Chapter 3: Accrual Accounting Flashcards
Why do accountants adjust accounts?
To properly reflect partially completed business activities.
Which type of accounting provides a better estimate of future cash flows?
- Accrual Accounting
- Cash-Basis Accounting
Accrual accounting
method of accounting in which revenue is recorded when cash is received, regardless of when it’s actually earned and an expenses is recorded when cash is paid, regardless of when it’s actually incurred
cash-basis accounting
Why do most companies NOT use cash-basis accounting?
may not reflect all assets and liabilities of a company at a a particular date
method of accounting in which revenues are generally recorded when earned and expenses are matched to the periods in which they help produce revenues (rather than when cash is paid)
accrual-basis accounting
Accrual-Basis Accounting is required by ________.
GAAP (generally accepted accounting principles)
Why is accrual accounting superior to cash-basis accounting?
It links income measurement to selling, the principal activity of a company.
Why is accrual accounting more complex than cash-basis accounting?
It records both cash and noncash transactions
When are revenues and expenses RECOGNIZED in accrual accounting?
- Revenues: when goods or services are delivered to customers
- Expenses: when they are incurred
What are the three key elements of accrual accounting?
- Time-Period Assumption
- Revenue Recognition Principle
- Expense Recognition Principle
allows companies to artificially divide their operations into time periods so they can satisfy users’ demands for information
time-period assumption
What does the revenue recognition principle state?
Revenue is recognized/recorded in the period in which a company satisfies its performance obligation, or promise within a contract.
What does the expense recognition principle state?
An expense is recorded when it is incurred, regardless of when cash is paid (key= match the expense to the revenue)
journal entries made at the end of an accounting period to record the completed portion of partially completed transactions
adjusting entries
Adjusting entries are necessary to apply what two principles?
- revenue recognition principle
- expense recognition principle
An unexpired portion of a service contract should be recorded as a _________ until the service is provided.
liability (unearned revenue)
Adjusting entries ensure that a company’s financial statements include the proper amount for what five things?
- Revenues
- Expenses
- Assets
- Liabilities
- Stockholder’s Equity
What are the two categories of adjusting entries?
Accruals and Deferrals
What are the two types of accruals?
- Accrued Revenues
- Accrued Expenses
What are accrued revenues?
Assets resulting from revenues that have been earned but for which no cash has yet been received
What are accrued expenses?
Liabilities arising from expenses that have been incurred but not yet paid in cash
What are the two types of deferrals?
- Deferred (unearned) Revenues
- Deferred (prepaid) Expenses
What are deferred (unearned) revenues?
liabilities arising from the receipt of cash for which revenue has not yet been earned
What are deferred (prepaid) expenses?
Assets arising from the payment of cash that have been used or consumed by the end of the period
All adjusting entries will effect at least one of what two things?
- At least one income statement
- At least one balance sheet account
Cash is (never/always) affected by adjustments.
never
What is the three-step procedure for making adjusting journal entries?
Step 1: Identify pairs of income statement and balance sheet accounts that require adjustment.
Step 2: Calculate the amount of the adjustment based on the amount of revenue that was earned or the amount of expense that was incurred during the accounting period.
Step 3: Record the adjusting journal entry.
previously unrecorded revenues that have been earned but for which no cash has yet been received
accrued revenues
For accrued revenues, an adjustment is necessary to record the revenue and the associated increase in a company’s assets, usually a _______.
receivable
previously unrecorded expenses that have been incurred, but not yet paid in cash
accrued expenses
For accrued expenses, an adjustment is necessary to record the expense and the associated increase in a company’s liabilities, usually a ________.
payable
transactions for which a company has received cash but not yet satisfied its performance obligations
deferred (unearned) revenues
For deferred (unearned) revenues, the unearned revenue account delays, or defers, the recognition of revenue by doing what?
recording the revenue as a liability until it is earned.
For deferred (unearned) revenues, an adjustment is necessary to ____ the previously recorded liability and to recognize the portion of revenue that has been earned. The portion of revenue that hasn’t been earned remains in the liability account, unearned revenue, until it is earned.
reduce
To decrease unearned revenue for a deferred revenue adjusting entry, how would you do this: debit unearned revenue or credit unearned revenue?
Debit unearned revenue
For deferred (prepaid) expenses, these prepayments are recorded as ________.
assets
For deferred (prepaid) expenses:
- As the prepaid asset is used to generate revenue, an adjustment is necessary to ______ the previously recorded prepaid asset and recognize the related ________. The portion of the prepaid asset that has not been used represents the unexpired benefits and remains in the asset account until it is used.
reduce; expense
the process whereby companies allocate the cost of their tangible operating assets (besides land) as an expense in each period in which the asset is used
depreciation
The depreciation process requires an adjustment to recognize the ______ incurred during the period and _______ the long-lived asset
expense; reduce
In regards to depreciation, the unused portion of a long-lived asset is reported on the:
balance sheet.
accounts that have a balance that is opposite of the balance in its related account
contra-accounts
Contra-accounts are used to _______ the amount of the long-lived asset in regards to depreciation.
reduce
For long-lived assets, the contra account is called ________ __________.
accumulated depreciation.
While an asset has a normal ______ balance, a contra asset has a normal _______ balance.
debit; credit
the contra asset account balance is _______ from the balance of the related asset account on the balance sheet, and the resulting difference is known as the ______ _______.
deducted; book value
represents the unused portion of the long-lived asset
book value
Why do the use of contra-accounts provide more information to users of the financial statements?
because it preserves both the original cost of the asset and the total cost that has expired to date.
How does an accrued revenue adjustment affect the following:
- assets
- revenue
- stockholder’s equity
- increases assets
- increases revenue
- increases stockholders equity
How does an accrued expense adjustment affect the following:
- liability
- expense
- stockholders equity
- increases liability
- increases expense
- decreases stockholders equity
How does a deferred revenue adjustment affect the following:
- liability
- revenue
- stockholders equity
- decreases liability
- increases revenue
- increases stockholders equity
How does a deferred expense adjustment affect the following:
- assets
- expense
-stockholders equity
- decreases assets
- increases expense
- decreases stockholders equity
Adjusting entries are (external/internal) events that do not involve another company.
internal
an updated trial balance that reflects the changes to account balances as the result of adjusting entries
adjusted trial balance
What is the primary source of information needed to prepare the financial statements?
adjusted trial balances
What does a company do after journalizing and posting all of the adjusting entries to reflect the adjustments that have been made?
Updates the trial balance (makes adjusted trial balance)
What does an adjusted trial balance do?
It lists all of the active accounts and proves the equality of debits and credits (similar to the unadjusted trial balance)
What is the specific order that financial statements are prepared in since they are interrelated?
- The income statement is prepared from the revenue and expense accounts.
- Net income (obtained from the income statement) and dividends are used to prepare the retained earnings statement.
- The balance sheet is prepared using the ending balance of retained earnings from the retained earnings statement.
accounts of asset, liability, and stockholders’ equity items whose balances are carried forward from the current accounting period to future accounting periods
permanent accounts
the accounts of revenue (and gains), expense (and losses), and dividend items that are used to collect the activities of only one period.
temporary accounts
The balance sheet accounts are (permanent/temporary) accounts.
permanent
What is the final step of the accounting cycle?
Closing the Accounts
Closing the Accounts is done to do what two things?
- Transfer the effects of revenue, expenses, and dividends to the permanent stockholders equity account: Retained Earnings.
- Clear the revenue, expenses, and dividends (reduce their balances to zero) so they are ready to accumulate the business activities of the next accounting period.
What are the three steps of Closing the Accounts?
- Close revenues (and gains) to Retained Earnings. Debit Revenues and Credit Retained Earnings.
- Close expenses (and losses) to Retained Earnings. Debit Retained Earnings and Credit Expenses.
- Close Dividends to Retained Earnings. Debit Retained Earnings and Credit Dividends.
Assets, expenses and dividends have a normal _______ balance.
debit
Revenues, liabilities and stockholders equity have a normal ______ balance.
credit
Revenues and gains, which have a normal ______ balance, are closed by _______ the revenue accounts.
credit; debiting
Expenses and losses, which have a normal _______ balance, are closed by _________ the expense accounts.
debit; crediting
the beginning and ending balance sheets are linked through the closing process. this relationship is known as
articulation of the financial statements
T or F: Net Income for Accrual Basis accounting only includes cash receipts (- common stock) and cash payments (- dividends).
False; accrual basis accounting DOESN’T include cash receipts or cash payments.
What does Net Income for Cash Basis Accounting Include?
ONLY includes cash receipts ( - common stock) and cash payments ( - dividends)
