Chapter 4: The Mechanics of Financial Accounting

Question 1

economic events

Answer 1

reflected in the financial statements must be both relevant to the financial condition of a company and objectively measurable in monetary terms

Question 2

relevant events

Answer 2

have economic significance to a particular company and include any occurrence that affects its financial condition. events like the election of a new president, or the signing of a new labor agreements (each of these events could have a significant impact on the financial resources of a particular company)

Question 3

objectivity

Answer 3

the dollar values assigned to the accounts on the financial statements must be determined in an objective manner. in general, a dollar value is considered objecting when two parties with differing incentives reach agreement. FB and WhatsApp reached an agreement on the value of WhatsApp (17.2 billion), which made that value “objective.”

Question 4

what is unfortunate about objectivity?

Answer 4

the most relevant information is not always the most objective

Question 5

assets as a mechanic

Answer 5

items and rights that a company acquires through the objectively measurable transactions that can be used in the future to generate economic benefit. assets come in three sources 1) they are borrowed 2) they are contributed by shareholders (owners) 3) they are generated by a company’s profitable operating activities

Question 6

liabilities as a mechanic

Answer 6

consists primarily of a company’s debts and payables. they are existing obligations for which assets must be used in the future to satisfy.

Question 7

shareholder’s equity as a mechanic

Answer 7

consists of two components 1) contributed capital (the dollar value of the assets contributed by shareholders) 2) retained earnings (the dollar value of the assets generated by operating activities and retained in the business

Question 8

alternative accounting equation

Answer 8

assets = liabilities + contributed capital + retained earnings

Question 9

business transactions

Answer 9

companies conduct operations by exchanging assets and liabilities with other entities

Question 10

transactions and the accounting equation

Answer 10

the idea here is that all transactions need to have a place twice on one side in +/- or need to be present on both sides of the equation for things to stay equal. the trick is knowing which category to put each transaction under

Question 11

accounts and the accounting equation

Answer 11

for purposes of recording transactions and preparing financial statements, the main components of the accounting equation (assets, liabilities, and SE) can be further subdivided into separate categories called accounts. accounts serve as storage units, where the dollar values of business transactions care initially recorded and later compiled into the financial statements

Question 12

what categories fall under the assets account?

Answer 12

cash, land, and receivables to name just a few

Question 13

what categories can fall under the liabilities account?

Answer 13

loans payable to name one

Question 14

what categories can fall under the SE account?

Answer 14

contributed capital and retained earnings to name two

Question 15

the balance sheet

Answer 15

the statement of the basic accounting equation as of a particular date: in this case, the end of 2017

Question 16

the statement of cash flows

Answer 16

this statement is prepared direction from the activity recorded in the cash account on a balance sheet. each dollar value on the cash flow statement corresponds to an increase or decrease in the cash account

Question 17

in summary, what is the statement of cash flows?

Answer 17

nothing more than a summary of the activity in the company’s cash account divided into three sections: operating, investing, and financing activities

Question 18

income statement

Answer 18

is a measure of the assets generated fro the company’s operating activities during a period fo time. it compares revenue (asset inflow due to the operating activities) to expenses (the asset outflows required to generate the revenues). the difference between the revenues and expenses is the net income/net loss

Question 19

in terms of the accounting equation, where are revenues, expenses, and dividends recorded?

Answer 19

in the retained earnings account. like the general categories of assets, liabilities, and shareholder’s equity, retained earnings can be further subdivided into revenue accounts, expense accounts, and dividend accounts.

Question 20

statement of shareholder’s equity

Answer 20

describes the changes during 2017 in the shareholders’ equity accounts - in this case, contributed capital and retained earnings. this account simply summarizes the activities in the contributed capital and retained earnings accounts

Question 21

journal entries

Answer 21

provide a more efficient way to represent such effects. they are used to represent relevant and measurable economic events, and their content and structure indicate how such events affect the accounting equation

Question 22

debit

Answer 22

to debit an account simply means to place the dollar amount assigned to an account on the left side of the journal entry (to debit is to increase)

Question 23

credit

Answer 23

placing a transaction on the right side of the journal entry is a credit (credit is always a decrease)

Question 24

the double entry system

Answer 24

journal entries that the total dollar value on the left side is equal to the total dollar value on the right side and that at least two different accounts were effected are characteristics of a double entry system.

Question 25

t accounts

Answer 25

so named because they in the form of a T - the left side of the T represents the debt side of the entry, and the right side corresponds to the credit side. when analyzing the effects of many economic events on the financial statements, it is useful to keep running tallies of the balances for each asset, liability, and SE, revenue, expense, and dividend account

Question 26

recognizing gains and losses

Answer 26

companies often sell investments and non-current assets, receiving dollar amounts that do not match the amounts at which the investments are carried on the balance sheet. in such cases, a gain or loss must be recognized in the amount of the difference between the proceeds and the carrying amount

Question 27

what does the gain or loss entry represent?

Answer 27

represents the profit or loss on the transaction in the amount of the difference between the proceeds and the balance sheet value of the investment. note that gain or loss appears on the income statement, and the cash proceeds from the sale would appear on the statement of cash flows under cash flows from investing activities

Question 28

accrual system of accounting

Answer 28

under this view, the revenues are booked when assets are created (or liabilities are discharged) and expenses are recorded when liabilities arise (or assets are reduced). in other words, revenues and expenses can be recognized either before or after the related cash is received or paid. the accrual system requires that period adjustments be made to the financial statements so that net income for a given period of time will be the result of a proper matching of the revenues and expenses within that period

Question 29

accruals

Answer 29

refer to amounts in asset and liability accounts that build up over time. the term accrue simply means to build up gradually

Question 30

accrued wages

Answer 30

in applying the accrual system, it must be recognized that although no cash has been paid as of December 32, a liability has been created to satisfy the remained of an earnings period of wages and salaries that weren’t paid prior to the period ending

Question 31

accrued interest

Answer 31

for any due interest that wasn’t paid prior to the closing of the books for that year, an account payable or interest receivable has to be made to make sure they pay it in a timely fashion

Question 32

deferrals

Answer 32

second type of adjustment, which are 1) recorded in the books at the end of an accounting period to achieve an appropriate matching of revenues and expenses and 2) do not reflect cash exchanges. they are called deferrals because they are entries that serve to defer the recognition of an expense to revenue until the proper time

Question 33

matching principle

Answer 33

involves a four step process 1) a cost is incurred in the current period for the purpose of generating revenue 2) the revenue recognition principle determines the period in which the revenue is recognized 3) if the revenue is recognized in the current period, the cost is expensed; if the revenue is expected to be recognized in a future period, the cost is capitalized (appearing on the balance sheet as an asset) 4) capitalized costs are converted to expenses in those future periods when revenue is recognized

Question 34

revaluation adjustments

Answer 34

such adjustments serve to restate certain accounts to keep their reported values in line with existing facts

Question 35

periodic adjustments

Answer 35

accruals and prepayments (deferrals)

Question 36

expense recognition principle (accrual accounting)

Answer 36

are recognized as incurred (used) (used employee’s time or used electricity)

Question 37

revenue recognition principle (accrual accounting)

Answer 37

recognize revenue in the period in which it is earned (when services are performed and goods are provided)