Chapter 3: Accrual Accounting And Income

Question 1

Accrual Accounting

Answer 1

Records the impact of a business transaction as it occurs. When a business performs a service the accountant records the transaction even if the business receives or pays no cash

Question 2

Cash-Basis Accounting

Answer 2

Records only cash transactions, cash receipts, and cash payments. Cash receipts are revenues and cash payments are expenses

Question 3

GAAP

Answer 3

Requires accrual accounting

Question 4

Balance Sheet Defect

Answer 4

If we fail to record a sale on account, the balance sheet reports no accounts receivable. Therefore assets are overstated

Question 5

Income Statement Defect

Answer 5

A sale on account provides revenue that increases the company’s wealth. Ignoring that understates revenue and net income on the income statement

Question 6

Cash transactions

Answer 6

Collecting cash from customers, receiving cash from interest earned, paying expenses, borrowing money, paying off loans, issuing stock

Question 7

Non-Cash transactions

Answer 7

Sales on account, purchases of inventory on account, accrual of expenses incurred but not yet paid, depreciation expense, usage of prepaid rent, and earning of revenue when cash was collected in advance

Question 8

Time Period Concept

Answer 8

Ensures that accounting information is reported at regular intervals. The basic accounting period is one year. A fiscal year ends any other date than December 31

Question 9

Revenue Principle

Answer 9

Deals with when to record revenue (make a journal entry) and the amount of revenue to record. Revenue must be recorded after it is earned. The amount of revenue to record is the cash value of the goods or services transferred to the customer

Question 10

Expense Recognition Principle

Answer 10

Deals with identifying all of the expenses incurred during the accounting period and measure the expenses, and recognize them in the same period in which any related revenues are earned

Question 11

What accounts need to be adjusted?

Answer 11

Accounts receivable, supplies, and prepaid rent must be adjusted because certain transactions have not been recorded

Question 12

Deferrals

Answer 12

Is an adjustment for payment of an item or receipt of cash in advance. Assets are used up and can become expensive. An adjusting entry is needed to update the asset account and the expense. There are also deferral adjustments for liabilities. A company may collect cash in advance of earning revenue which is called unearned service revenue

Question 13

Depreciation

Answer 13

Allocates the cost of a plant asset to expense over the assets useful life. Depreciation is the most common long term deferral. Records wear and tear of assets

Question 14

Accruals

Answer 14

Is the opposite of a deferral. An accrual is recording an expense or revenue before cash is collected.

Question 15

Examples of Accruals

Answer 15

Income tax expense and interest expense

Question 16

Prepaid Expenses

Answer 16

Is an expense that is paid in advance. Are assets because they provide a future benefit to the company

Question 17

Plant Assets

Answer 17

Are long lived tangible assets, such as land, buildings, furniture, and equipment. All plant assets except for land decline in usefulness and this decline is an expense. Depreciation is the process of allocating cost to expense for a long term plant asset

Question 18

Accumulated Depreciation

Answer 18

The account that shows the sum of all depreciation expense from using the asset. The balance increases over the useful life

Question 19

Contra Account

Answer 19

Always has a companion account and its normal balance is opposite that of the companion account. Accumulated depreciation is the contra account to equipment

Question 20

Book Value (of a plant asset)

Answer 20

The net amount of a plant asset (cost minus accumulated depreciation) is the assets carrying cost

Question 21

Accrued Expense

Answer 21

Refers to a liability that arises from an expense that has not yet been paid. Companies don’t record accrued expenses daily or weekly. Instead, they wait until the end of the period and use an adjusting entry to update each expense

Question 22

Accrued Revenues

Answer 22

Businesses often earn revenue before they receive the cash. A revenue that has been earned but not yet collected

Question 23

Unearned Revenue

Answer 23

Some businesses collect cash from customers before earning the revenue. This creates a liability. Only when the job is completed does the business earn the revenue

Question 24

Adjusted Trial Balance

Answer 24

Lists all of the accounts and their balances in a single place

Question 25

Closing the Books

Answer 25

Means to prepare the accounts for the next periods transactions

Question 26

Closing Entries

Answer 26

Set the revenue, expenses, and dividend balances back to 0 at the end of the period

Question 27

Temporary Accounts

Answer 27

The closing process involves only revenues, expenses, and dividends

Question 28

Permanent Accounts

Answer 28

Assets, liabilities, and stockholder’s equity are permanent accounts because they are the beginning balances of the next period

Question 29

First Step to Close the Accounts

Answer 29

Debit each revenue account for the amount of its credit balance. Credit retained earnings

Question 30

Second Step to Close the Accounts

Answer 30

Credit each expense account for the amount of the debit balance. Debit retained earnings

Question 31

Third step to close the accounts

Answer 31

Credit the dividends account for the amount of the debit balance. Debit retained earnings

Question 32

Liquidity

Answer 32

Measures how quickly an item can be converted to cash

Question 33

Liquidity of Current Assets

Answer 33

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

Question 34

Operating Cycle

Answer 34

Is the time span during which cash is paid for goods and services, and these goods and services are sold to bring in cash

Question 35

Liquidity of Long Term Assets

Answer 35

Are all assets not classified as current assets. Plant assets is the most common with property and plant, land, and buildings

Question 36

Liquidity of Current Liabilities

Answer 36

The sooner a liability must be paid l, the higher up the balance sheet it must be placed

Question 37

Liquidity of Long Term Liabilities

Answer 37

Many notes payable are long term. Placed after current liabilities on the balance sheet

Question 38

Balance Sheet Formats

Answer 38

Report format and account format

Question 39

Report Format

Answer 39

Lists the assets at the top followed by liabilities and stockholder’s equity

Question 40

Account Format

Answer 40

Lists the assets on the left and the liabilities and stockholder’s equity on the right side similar to t accounts

Question 41

Income Statement Formats

Answer 41

Single step and multi step formats

Question 42

Single Step Income Statement

Answer 42

Lists all of the revenues together under one heading and all of the expenses under another heading

Question 43

Multi Step Income Statement

Answer 43

Reports a number of subtotals to highlight important relationships between revenues and expenses

Question 44

Net Working Capital

Answer 44

Is computational data that represents operating liquidity.

Question 45

Net Working Capital Formula

Answer 45

Net Working Capital = Total Current Assets - Total Current Liabilities

Question 46

Current Ratio

Answer 46

Expressing operating data through the relationship between current assets and current liabilities

Question 47

Current Ratio Formula

Answer 47

Current Ratio = Total Current Assets/ Total Current Liabilities

Question 48

Debt Ratio

Answer 48

Includes the proportion of a company’s assets that is financed with debt. A lower debt ratio is better than a high debt ratio.

Question 49

Debt Ratio Formula

Answer 49

Debt Ratio = Total Liabilities/ Total Assets