Chapter 3: Accrual Accounting

Question 1

Why do accountants adjust accounts?

Answer 1

To properly reflect partially completed business activities.

Question 2

Which type of accounting provides a better estimate of future cash flows?
- Accrual Accounting
- Cash-Basis Accounting

Answer 2

Accrual accounting

Question 3

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

Answer 3

cash-basis accounting

Question 4

Why do most companies NOT use cash-basis accounting?

Answer 4

may not reflect all assets and liabilities of a company at a a particular date

Question 5

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)

Answer 5

accrual-basis accounting

Question 6

Accrual-Basis Accounting is required by ________.

Answer 6

GAAP (generally accepted accounting principles)

Question 7

Why is accrual accounting superior to cash-basis accounting?

Answer 7

It links income measurement to selling, the principal activity of a company.

Question 8

Why is accrual accounting more complex than cash-basis accounting?

Answer 8

It records both cash and noncash transactions

Question 9

When are revenues and expenses RECOGNIZED in accrual accounting?

Answer 9

• Revenues: when goods or services are delivered to customers
• Expenses: when they are incurred

Question 10

What are the three key elements of accrual accounting?

Answer 10

1. Time-Period Assumption
2. Revenue Recognition Principle
3. Expense Recognition Principle

Question 11

allows companies to artificially divide their operations into time periods so they can satisfy users’ demands for information

Answer 11

time-period assumption

Question 12

What does the revenue recognition principle state?

Answer 12

Revenue is recognized/recorded in the period in which a company satisfies its performance obligation, or promise within a contract.

Question 13

What does the expense recognition principle state?

Answer 13

An expense is recorded when it is incurred, regardless of when cash is paid (key= match the expense to the revenue)

Question 14

journal entries made at the end of an accounting period to record the completed portion of partially completed transactions

Answer 14

adjusting entries

Question 15

Adjusting entries are necessary to apply what two principles?

Answer 15

• revenue recognition principle
• expense recognition principle

Question 16

An unexpired portion of a service contract should be recorded as a _________ until the service is provided.

Answer 16

liability (unearned revenue)

Question 17

Adjusting entries ensure that a company’s financial statements include the proper amount for what five things?

Answer 17

1. Revenues
2. Expenses
3. Assets
4. Liabilities
5. Stockholder’s Equity

Question 18

What are the two categories of adjusting entries?

Answer 18

Accruals and Deferrals

Question 19

What are the two types of accruals?

Answer 19

1. Accrued Revenues
2. Accrued Expenses

Question 20

What are accrued revenues?

Answer 20

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

Question 21

What are accrued expenses?

Answer 21

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

Question 22

What are the two types of deferrals?

Answer 22

1. Deferred (unearned) Revenues
2. Deferred (prepaid) Expenses

Question 23

What are deferred (unearned) revenues?

Answer 23

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

Question 24

What are deferred (prepaid) expenses?

Answer 24

Assets arising from the payment of cash that have been used or consumed by the end of the period

Question 25

All adjusting entries will effect at least one of what two things?

Answer 25

1. At least one income statement 2. At least one balance sheet account

Question 26

Cash is (never/always) affected by adjustments.

Answer 26

never

Question 27

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

Answer 27

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.

Question 28

previously unrecorded revenues that have been earned but for which no cash has yet been received

Answer 28

accrued revenues

Question 29

For accrued revenues, an adjustment is necessary to record the revenue and the associated increase in a company's assets, usually a _______.

Answer 29

receivable

Question 30

previously unrecorded expenses that have been incurred, but not yet paid in cash

Answer 30

accrued expenses

Question 31

For accrued expenses, an adjustment is necessary to record the expense and the associated increase in a company's liabilities, usually a ________.

Answer 31

payable

Question 32

transactions for which a company has received cash but not yet satisfied its performance obligations

Answer 32

deferred (unearned) revenues

Question 33

For deferred (unearned) revenues, the unearned revenue account delays, or defers, the recognition of revenue by doing what?

Answer 33

recording the revenue as a liability until it is earned.

Question 34

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.

Answer 34

reduce

Question 35

To decrease unearned revenue for a deferred revenue adjusting entry, how would you do this: debit unearned revenue or credit unearned revenue?

Answer 35

Debit unearned revenue

Question 36

For deferred (prepaid) expenses, these prepayments are recorded as ________.

Answer 36

assets

Question 37

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.

Answer 37

reduce; expense

Question 38

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

Answer 38

depreciation

Question 39

The depreciation process requires an adjustment to recognize the ______ incurred during the period and _______ the long-lived asset

Answer 39

expense; reduce

Question 40

In regards to depreciation, the unused portion of a long-lived asset is reported on the:

Answer 40

balance sheet.

Question 41

accounts that have a balance that is opposite of the balance in its related account

Answer 41

contra-accounts

Question 42

Contra-accounts are used to _______ the amount of the long-lived asset in regards to depreciation.

Answer 42

reduce

Question 43

For long-lived assets, the contra account is called ________ __________.

Answer 43

accumulated depreciation.

Question 44

While an asset has a normal ______ balance, a contra asset has a normal _______ balance.

Answer 44

debit; credit

Question 45

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 ______ _______.

Answer 45

deducted; book value

Question 46

represents the unused portion of the long-lived asset

Answer 46

book value

Question 47

Why do the use of contra-accounts provide more information to users of the financial statements?

Answer 47

because it preserves both the original cost of the asset and the total cost that has expired to date.

Question 48

How does an accrued revenue adjustment affect the following: - assets - revenue - stockholder's equity

Answer 48

- increases assets - increases revenue - increases stockholders equity

Question 49

How does an accrued expense adjustment affect the following: - liability - expense - stockholders equity

Answer 49

- increases liability - increases expense - decreases stockholders equity

Question 50

How does a deferred revenue adjustment affect the following: - liability - revenue - stockholders equity

Answer 50

- decreases liability - increases revenue - increases stockholders equity

Question 51

How does a deferred expense adjustment affect the following: - assets - expense -stockholders equity

Answer 51

- decreases assets - increases expense - decreases stockholders equity

Question 52

Adjusting entries are (external/internal) events that do not involve another company.

Answer 52

internal

Question 53

an updated trial balance that reflects the changes to account balances as the result of adjusting entries

Answer 53

adjusted trial balance

Question 54

What is the primary source of information needed to prepare the financial statements?

Answer 54

adjusted trial balances

Question 55

What does a company do after journalizing and posting all of the adjusting entries to reflect the adjustments that have been made?

Answer 55

Updates the trial balance (makes adjusted trial balance)

Question 56

What does an adjusted trial balance do?

Answer 56

It lists all of the active accounts and proves the equality of debits and credits (similar to the unadjusted trial balance)

Question 57

What is the specific order that financial statements are prepared in since they are interrelated?

Answer 57

1. The income statement is prepared from the revenue and expense accounts. 2. Net income (obtained from the income statement) and dividends 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 58

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

Answer 58

permanent accounts

Question 59

the accounts of revenue (and gains), expense (and losses), and dividend items that are used to collect the activities of only one period.

Answer 59

temporary accounts

Question 60

The balance sheet accounts are (permanent/temporary) accounts.

Answer 60

permanent

Question 61

What is the final step of the accounting cycle?

Answer 61

Closing the Accounts

Question 62

Closing the Accounts is done to do what two things?

Answer 62

1. Transfer the effects of revenue, expenses, and dividends to the permanent stockholders equity account: Retained Earnings. 2. 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.

Question 63

What are the three steps of Closing the Accounts?

Answer 63

1. Close revenues (and gains) to Retained Earnings. Debit Revenues and Credit Retained Earnings. 2. Close expenses (and losses) to Retained Earnings. Debit Retained Earnings and Credit Expenses. 3. Close Dividends to Retained Earnings. Debit Retained Earnings and Credit Dividends.

Question 64

Assets, expenses and dividends have a normal _______ balance.

Answer 64

debit

Question 65

Revenues, liabilities and stockholders equity have a normal ______ balance.

Answer 65

credit

Question 66

Revenues and gains, which have a normal ______ balance, are closed by _______ the revenue accounts.

Answer 66

credit; debiting

Question 67

Expenses and losses, which have a normal _______ balance, are closed by _________ the expense accounts.

Answer 67

debit; crediting

Question 68

the beginning and ending balance sheets are linked through the closing process. this relationship is known as

Answer 68

articulation of the financial statements

Question 69

T or F: Net Income for Accrual Basis accounting only includes cash receipts (- common stock) and cash payments (- dividends).

Answer 69

False; accrual basis accounting DOESN'T include cash receipts or cash payments.

Question 70

What does Net Income for Cash Basis Accounting Include?

Answer 70

ONLY includes cash receipts ( - common stock) and cash payments ( - dividends)