Chapter 3 - Adjusting Accounts for Financial Statements

Question 1

Depreciation

Answer 1

The process of allocating the costs of long-term tangible assets over their expected useful lives.

Question 2

Plant assets

Answer 2

• A special category of PREPAID EXPENSES
• Costs of these assets are gradually reported as expenses on Income Statement over it’s useful life
• Long term tangible assets used to produce and sell products or services
• Provide benefits for more than one period
• Eventually wear out or decline in usefulness
• Ex: Buildings, machines, vehicles, fixtures

Question 3

Accrual basis accounting

Answer 3

Applies adjustments so that revenues are recognized when services and products are delivered, and expenses are recognized when incurred.

Follows GAAP

Question 4

Cash basis accounting

Answer 4

Recognizes revenue when cash is received and records expenses when cash is paid.

Does not follow GAAP

Question 5

4 Types of Adjustments

Answer 5

1. Prepaid Expenses
2. Unearned Revenues
3. Accrued Expenses
4. Accrued Revenues

Question 6

Adjusting entry

Answer 6

Made at the end of an accounting period, to reflect a transaction or event that is not yet recorded.

Always affects accounts on Income Statement and Balance Sheet. Never the cash account.

Question 7

Accumulated depreciation

Answer 7

A CONTRA ASSET account that has a normal balance of CREDIT and it’s reported on the balance sheet.

Question 8

Calculating deprecation

Answer 8

Total cost - salvage cost / useful life

Question 9

Prepaid Expenses

Answer 9

Pay for something in advance of receiving. When used their costs become expenses.

Turning and asset into an expense.

DECREASE an Asset
INCREASE an Expense

Question 10

Unearned Revenues

Answer 10

Received cash but have not provided service yet.

A liability because you OWE a service.

Adjusting the entry:

DECREASE a Lability
INCREASE the Revenue

Question 11

Accrued Expenses

Answer 11

Incur an expense that is not yet paid for.

A liability because you OWE money for expense.

INCREASE a LIABILITY
INCREASE an EXPENSE

Ex - Wages expense, an account with supplier

Question 12

Formula for computing accrued interest expense

Answer 12

Principle amount x Annual interest rate x Fraction of year since last payment date

Question 13

Adjusted trial balance

Answer 13

List of accounts and balances prepared after adjusting entries have been recorded and posted to ledger

Can prepare financial statement directly from adjusted trial balance

Question 14

Closing process

Answer 14

Done at the end of an accounting period and AFTER FINANCIAL statements

Prepares accounts for recording of the next period

Question 15

Purpose of closing process

Answer 15

1. Resets revenue, expense, and dividends accounts

2. Helps summarize a period’s revenues and expenses

Question 16

Steps to close temporary accounts

Answer 16

Step 1 - Close credit balances in Revenue Accounts
Step 2 - Close debit balances in Expense Accounts
Step 3 - Close Income Summary to Retained Earnings
Step 4 - Close Dividends Accounts to Retained Earnings

Question 17

Accrued Revenue

Answer 17

Provided a service but have not been paid.

An asset

INCREASE an Asset
INCREASE Revenue

Ex - Services revenue in accounts receivable

Question 18

Profit Margin =

Answer 18

Net Income / Net Sales

Question 19

Current Ratio =

Answer 19

Current Assets / Current Liabilities

Question 20

Post closing trail balance

Answer 20

List of PERMANENT accounts after all closing entries have been journalists.

Aim:

1. verify total debits equal total credits for permanent accounts
2. verify all temporary accounts have zero balances

Question 21

Closing entries

Answer 21

Transfer of the end-of-period balances in revenue, expense, and dividends account to the permanent Retained Earnings account.

Question 22

Steps in Accounting Cycle

Answer 22

1. Analyze transaction
2. Journalize (or record accounts)
3. Post to General Ledger
4. Prepare unadjusted trial balance
5. Adjust and pots accounts
6. Prepare adjusted trail balance
7. Prepare financial statements
8. Close accounts
9. Prepare post closing trial balance
10. Reverse and post (optional)

Question 23

Unclassified Balance Sheet

Answer 23

Broadly groups accounts into assets, liabilities, and equity.

Question 24

Classified Balance Sheet

Answer 24

Organizes assets and liabilities into sub groups.

These sub groups provide more information to decision makers.

Question 25

“Current” items on classified balance sheet

Answer 25

Either collected or owed within one year or the company’s operating cycle

Question 26

Assets on Classified Balance Sheet

Answer 26

• Current Assets (always listed first)
• Long term investments
• Plant assets
• Intangible assets

Question 27

Liabilities on a Classified Balance Sheet

Answer 27

• Current liabilities (always listed first)

- Long Term liabilities

Question 28

Prepaid Alternative Adjustment

Answer 28

Recording entire expense as debit to expense account.

ADJUSTMENT - Any unexpired or unused cost must be transferred to Prepaid Expense (asset) account.

Question 29

Unearned Revenue Alternative Adjustment

Answer 29

Recording entire amount earned with a credit to revenue account.

ADJUSTMENT - Any unearned revenue must be transferred to Unearned Revenue (liability) account.