Chapter 3 Terms

Question 1

The cash to cash sequence of transactions.

1.Operations begin with some cash on hand.

2.Cash is used to purchase supplies and to pay expenses.

3. Revenue is earned as repair services are completed for customers.
4. Cash is collected from customers.

Answer 1

operating cycle

Question 2

Recording revenue in the accounting period in which it was earned.

The process of documenting revenue when the service was performed (when a sales invoice has been sent), and not waiting until the customer has paid cash.

Answer 2

revenue recognition

Question 3

The process of recognizing revenues when earned and expenses when incurred regardless of when cash is exchanged, forming the basis of GAAP principle of recognition.

Answer 3

accrual accounting

Question 4

Recording expenses in the accounting period in which the assets were used.

The process of documenting expenses when the service was received (when a sales invoice has been sent), and not waiting until the company has paid for it. Sometimes an expense can be paid for in advance, and thus the expense will not be recorded when cash is paid, rather you would wait until the service is received.

Answer 4

expense recognition

Question 5

Requires that expenses be reported in the same period as the revenues they helped generate. It ignores when cash changed hands.

Answer 5

matching principle

Question 6

What are the five types of adjustments?

Answer 6

1. Prepaid assets
2. Unearned liabilities
3. Plant and equipment assets
4. Accrued revenues
5. Accrued expenses

“PUPAA”

Question 7

Revenue that has been earned but has not been collected or recorded.

Answer 7

accrued revenue

Question 8

An expense that has been incurred but has not yet been paid or recorded.

Answer 8

accrued expense

Question 9

An account that appears both on the balance sheet and on the income statement.

E.g.: an asset account requiring adjustment or a liability account requiring adjustment appear on both.

Answer 9

mixed account

Question 10

1. Recorded as assets when costs are incurred to produce revenue in future accounting periods (prepaid rent, prepaid insurance, and unused supplies)
2. Recorded as expenses when costs are incurred to earn revenue in the present accounting period (rent expense, insurance expense, office supplies expense)

Answer 10

two types of cost outlays

Question 11

trial balance where the accounts have not yet been adjusted

Answer 11

unadjusted trial balance

Question 12

the name of the record of adjustment

Answer 12

adjusting entries

Question 13

the process of allocating the cost of a plant and equipment asset over the period of time it is expected to be used

Answer 13

depreciation

Question 14

an estimate of how long the asset will actually be used by the business regardless of how long the asset is expected to last

Answer 14

useful life

Question 15

an estimate of what the plant and equipment asset will be sold for when it is no longer used by a business

Answer 15

residual value

Question 16

(cost - estimated residual value) / estimated useful life

Answer 16

straight-line method of depreciation

Question 17

cost minus estimated residual value

Answer 17

depreciable cost

Question 18

an account that is related to another account and typically has an opposite normal balance that is subtracted from the balance of its related account on the financial statements

Answer 18

contra account

Question 19

the amount of the asset’s cost that has been expensed since it was put into use; has a normal credit balance that is subtracted from a plant and equipment asset account on the balance sheet

Answer 19

accumulated depreciation

Question 20

plant and equipment asset minus accumulated depreciation

Answer 20

carrying amount / net book value

Question 21

Interest equation

Answer 21

interest =Principal (dollars)* Rate (annual rate)* Time (years)

Question 22

Accounting Cycle (long version)

Answer 22

1. general journal
2. posted to general ledger
3. unadjusted trial balance
4. adjusting entries journalized in general journal
5. adjusted trial balance
6. prepare financial statements
7. closing entries journalized and posted
8. post-closing trial balance

Question 23

transfer each revenue and expense account balance, as well as any balance in the Dividend account, into retained earnings.

Answer 23

closing entries

Question 24

revenues, expenses, dividends

Answer 24

temporary accounts because their balances are zeroed at the end of each accounting period

Question 25

accounts that have a continuing balance from one fiscal year to the next

Answer 25

permanent accounts

Question 26

a checkpoint used to make sure all revenue and expense account balances are closed and reported properly; it must equal the net income/loss reported on the income statement

Answer 26

income summary

Question 27

prepared immediately following the posting of closing entries

Answer 27

post-closing trial balance

Question 28

Specific adjustment entry for accrued expense. Give an example with salaries.

Answer 28

Supplier or employee performed service; company has not yet paid

The salaries have been paid to a certain point but at the end of the month, you may find that there are days the employee worked but that they are not going to receive their pay until next month. In this case you count the number of days left in the month where they are not paid, and do the following:

June 30 Salaries Expense 142.86
Salaries Payable 142.86

This will be the first time the salaries payable account is touched.

Beforehand the paychecks would have looked like this:

June 14 Salaries Expense 1000
Cash 1000

June 28 Salaries Expense 1000
Cash 1000

And so the 143 comes from the salary for two days, those that are unpaid by the end of the accounting cycle or month (I am not sure on where this works)

Question 29

Specific adjustment entry for accrued expense. Give an example with Interest.

Answer 29

Supplier performed service; company has not yet paid and will not have paid it at the end of the month

Imagine you got a loan out for $1000 on June 1 with an interest rate of 4% per year and they do not expect you to pay interest until the 10th of the next month, so July 10. But you are doing your adjustment entries on June 30.

You would first calculate how much interest expense has accrued by using the interest equation:
I = PRT
Interest = Principal x Rate x Time

Make sure that the rate and time use the same unit for time. Here we are using years.

I = $1000(0.04/year)(1/12 year)
I = $3.33

This is what will be payable after 1 month, or 1/12 of a year.

The adjustment entry would look like this:

June 30 Interest Expense 3.33
Interest Payable 3.33
To adjust for accrued interest for the month of June on the $1000 bank loan on 4% per year.

If you have already paid an amount towards the interest that month, make sure to account for it by subtracting that amount from the total interest payable and from the interest expense. Your adjustment entry should only be about the amount of accrued interest that is unpaid by the end of the month.

Question 30

Specific Adjustment Entry Unearned Liabilities / Adjustment of unearned revenue. Give an example with rent.

Answer 30

Customer paid; Company has not yet performed service

Someone rents from you and pays you in advance for the month coming up. It looks like this when they make the payment:

June 1 Cash 500
Unearned Rent 500

Then the adjustment entry looks like this
June 30 Unearned rent 500
Rent earned 500

So you are acknowledging that you actually have revenue now that the tenants have enjoyed the space. This is called revenue recognition.

Question 31

Specific Adjustment Entry PPE. Give an example with depreciating furniture.

Answer 31

Recognizing the depreciation using depreciation expense and the accumulated depreciation accounts

You buy furniture on June 10th worth $1000 and it will last for 10 years with no residual value.

June 10 Furniture 1000
Cash 1000

Then you would realize that the depreciation must be calculated:

$1000 / 10 gives the depreciation over one year

$100 per year means $100/12 per month so 8.33

Then 2.78 per twenty days that it was depreciating in June.

The adjustment entry would look like this:

June 30 Depreciation expense, furniture 2.78
Accumulated depreciation 2.78

Then on the balance sheet you would use the accumulated depreciation and the furniture original cost in order to show what value remains on the furniture. This is done only on the balance sheet. No subtraction of depreciation is ever done on the account for furniture itself.
E.g.
Assets
….
PPE
Furniture 1000
Accumulated Depreciation on furniture 2.78 1000-2.78
Land 150000
Total PPE Some number

Question 32

Describe the main function of the 5 types of adjustment entries.

Answer 32

1. Prepaid Assets: adjustment of prepaid
   Company paid in advance; now the expense is recognized
   Look for “prepaid” and “expense” type accounts together in one journal entry to identify this adjustment entry
2. Unearned liabilities: adjustment of unearned revenue
   Customer paid; Company has not yet performed service when the original entry was made; now time has passed and some or all revenue is now earned and we must adjust for the revenue that is now earned
3. Plant and Equipment Assets: depreciation adjustment
   Recognizing the depreciation using depreciation expense and the accumulated depreciation accounts
4. Accrued Revenue:
   Company has performed the service (more like it is accumulating over time so every moment the company is giving value to the customer); customer has not yet paid (and we have not accounted for this work that has been done by the company during the month) but we recognize the revenue in an adjustment entry.
5. Accrued Expense:
   Supplier performed service (more like it is accumulating over time though, so every moment more of the service is being used by the company); company has not yet paid but we recognize the expense in an adjustment entry

Question 33

Describe the main function of the first type of adjustment entry.

Answer 33

1. Prepaid Assets: adjustment of prepaid
   Company paid in advance; now the expense is recognized
   Look for “prepaid” and “expense” type accounts together in one journal entry to identify this adjustment entry

Rent expense 750
Prepaid rent 750

Question 34

Describe the main function of the second type of adjustment entry.

Answer 34

2. Unearned liabilities: adjustment of unearned revenue
   Customer paid; Company has not yet performed service when it was first paid; now we are recognizing that all or a portion of that payment is actually earned since time has passed and we adjust like this:

Unearned rent 1500
Rent earned 1500

Question 35

Describe the main function of the third type of adjustment entry.

Answer 35

3. Plant and Equipment Assets: depreciation adjustment
   Recognizing the depreciation using depreciation expense and the accumulated depreciation accounts

Depreciation expense, furniture 200
Accumulated depreciation, furniture 200

Question 36

Describe the main function of the fourth type of adjustment entry and the journal entry to do the adjustment.

Answer 36

4. Accrued Revenue:
   Company has performed the service; customer has not yet paid

Debit Accounts receivable
Credit Revenue earned

Question 37

Describe the main function of the fifth type of adjustment entry.

Answer 37

5. Accrued Expense:
   Supplier performed service; company has not yet paid

Interest Expense 3.33
Interest Payable 3.33

(salaries works too)