Chapter 4: Accrual Accounting

Question 1

Accrual‐basis accounting

Answer 1

Accounting basis in which companies record, in the periods in which the events occur, transactions that change a company’s financial statements, even if cash was not exchanged.

• Records revenues and expenses before cash is received or paid
• Also called revenue recognition principle
• Requires that sales revenues be recognized when the goods are transferred from the seller to the buyer

Question 2

Accrued expenses

Answer 2

Expenses incurred but not yet paid in cash or recorded.
- Accruals are always a receivable for one party and a payable for the other party of a service or benefit provided
- Increase debit expense, decrease credit liability
- Ex: Interest
taxes
utilities
salaries

Question 3

Accrued revenues

Answer 3

Revenues for services performed but not yet received in cash or recorded.
- Increase debit asset, decrease credit revenue, increase revenues
- Ex: rent
interest
services performed

Question 4

Adjusted trial balance

Answer 4

A list of accounts and their balances after all adjustments have been made.

Question 5

Adjusting entries

Answer 5

Entries made at the end of an accounting period to ensure that the revenue recognition and expense recognition principles are followed.
- In order for revenues to be recorded in the period in which the services are performed, and for expenses to be recognized in the period in which they are incurred:

Question 6

Book value

Answer 6

The difference between the cost of a depreciable asset and its related accumulated depreciation.

Question 7

Cash‐basis accounting

Answer 7

Accounting basis in which a company records revenue only when it receives cash and an expense only when it pays cash.

• Does not follow GAAP
• Records revenues when cash is received
• Records expenses when cash is paid

Question 8

Closing entries

Answer 8

Entries at the end of an accounting period to transfer the balances of temporary accounts to a permanent stockholders’ equity account, Retained Earnings.

Question 9

Contra asset account

Answer 9

An account that is offset against an asset account on the balance sheet.
- Ex: Accumulated Depreciation

Question 10

Depreciation

Answer 10

The process of allocating the cost of an asset to expense over its useful life.
- Ex of Special Long term deferrals:
Truck
        Cash or Note payable
Depreciation expense
          Accumulated depreciation-Truck
- Equation:
Depreciation Lost Per Year = Cost - Salvage value/Number of years

Question 11

Earnings management

Answer 11

The planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income.

Question 12

Expense recognition principle (matching principle)

Answer 12

The principle that matches expenses with revenues in the period when the company makes efforts to generate those revenues.

Question 13

Fiscal year

Answer 13

An accounting period that is one year long.

Question 14

Income Summary

Answer 14

A temporary account used in closing revenue and expense accounts.

Question 15

Periodicity assumption

Answer 15

An assumption that the economic life of a business can be divided into artificial time periods.

Question 16

Permanent accounts

Answer 16

Balance sheet accounts whose balances are carried forward to the next accounting period.

Question 17

Post‐closing trial balance

Answer 17

A list of permanent accounts and their balances after a company has journalized and posted closing entries.

Question 18

Prepaid expenses (prepayments)

Answer 18

Expenses paid in cash before they are used or consumed.
- Ex: Prepaid rent, prepaid insurance, supplies
- Increase debit expense, decrease credit asset
Insurance
supplies
advertising
rent
Depreciation:
equipment
buildings

Question 19

Quality of earnings

Answer 19

Indicates the level of full and transparent information that a company provides to users of its financial statements.

Question 20

Revenue recognition principle

Answer 20

The principle that companies recognize revenue in the accounting period in which the performance obligation is satisfied.

Question 21

Reversing entry

Answer 21

An entry made at the beginning of the next accounting period; the exact opposite of the adjusting entry made in the previous period.

Question 22

Temporary accounts

Answer 22

Revenue, expense, and dividend accounts whose balances a company transfers to Retained Earnings at the end of an accounting period.

Question 23

Unearned revenues

Answer 23

Cash received and a liability recorded before services are performed.
- Both deferrals and liabilities
- Decrease debit liabilities, increase credit revenue
- Ex: rent
airline tickets
magazine subscriptions
customer deposits

Question 24

Useful life

Answer 24

The length of service of a productive asset.

Question 25

Deferals

Answer 25

Recognizing Revenue/expenses AFTER cash is received/paid
- Deferred (Unearned) Revenue
- Deferred (Prepaid) Expense
- Ex: Cash
              Deferred Rent Revenue
         Prepaid Rent
               Cash

Question 26

Accruals

Answer 26

Recognizing Revenue/expenses BEFORE cash is 
- Accrued Revenue
- Accrued Expense
- Ex: Interest Receivable
              Interest Revenue
         Accounts receivable 
                Revenues fees
          Interest Expense
                 Interest Payable
          Free expense
                  Accounts payable

Question 27

Contra revenue account

Answer 27

An account that is offset against a revenue account on the balance sheet.
- Ex: Sales returns and allowances