Chapter Three: Adjusting Accounts for Financial Statements

Question 1

Deferral:

Answer 1

The act of delaying.

Question 2

Deferral of Expense:

Answer 2

Delayed Expense?

Question 3

Prepaid Expenses:

Answer 3

Assets paid for in advance of receiving their benefits. When these assets are used, the advance payment becomes expenses.

Question 4

Depreciation:

Answer 4

Represents an asset’s decrease in value over a specific timeframe.

Question 5

Accumulated Depreciation:

Answer 5

Accumulated reduction in the value of an asset over time or the total depreciation on an asset since you bought it.

When an asset is first purchased, it’s typically assigned a value reflecting its expected lifespan, gradually reducing over time. Accumulated depreciation is the total of this depreciation to date.

How to use:

When you purchase an asset, it’ll have value. You record the amount it depreciates as an accumulated depreciation expense on your asset ledger. This accumulated depreciation figure is used to offset the reducing value of the asset.

Question 6

Contra Account:

Answer 6

A contra account is an account linked with another account. It has an opposite normal balance and is a subtraction from that other account’s balance.

Question 7

Unearned Revenue:

Answer 7

Cash received in advance of providing products and services. When cash is accepted, the company has a liability to provide products or services.

Question 8

Accrued Expense:

Answer 8

Costs incurred in a period that are both unpaid and unrecorded. They are reported on the income statement for the period when incurred.

Equation: Principle amount owed * Annual interest rate * Fraction of year since last payment = Accrued expense

Question 9

Accrued Revenue:

Answer 9

Revenues earned in a period that are both unrecorded and not yet received in cash.

Question 10

Unadjusted Trial Balance:

Answer 10

A list of ledger accounts and balances before adjustments are recorded.

Question 11

Adjusted Trial Balance:

Answer 11

A list of accounts and balances after adjusting entries have been recorded and posted to the ledger.

Question 12

Steps to Prepare Financial Statements:

Answer 12

1. Prepare income statement using revenue and expense accounts from trial balance.
2. Prepare statement of retained earnings using retained earnings and dividends from trial balance; pull net income from step 1.
3. Prepare balance sheet using asset and liability accounts along with common stock from trial balance; pull updated retained earnings from step 2.
4. Prepare statement of cash flows from changes in cash flows for the period (learn about in later chapters).

Question 13

Closing Process:

Answer 13

Occurs at period-end after financial statements have been prepared. Resets revenue, expense, and dividends balances to zero.

Question 14

Four-Step Closing Process:

Answer 14

1. Close income statement credit balances.
2. Close income statement debit balances.
3. Close Income Summary account.
4. Close dividends account.

Question 15

Temporary Accounts:

Answer 15

Closed at period-end. They consist of revenue, expense, dividends, and Income Summary.

Question 16

Permanent Accounts:

Answer 16

Not closed at period-end. They consist of asset, liability, common stock, and retained earnings (all balance sheet accounts).

Question 17

Income Summary:

Answer 17

A temporary amount only used for the closing process that has a credit for total revenues and a debit for total expenses.

Question 18

Post-Closing Trial Balance:

Answer 18

A list of permanent accounts (assets, liabilities, equity) and their balances after all closing entries.

Question 19

Classified Balance Sheet:

Answer 19

Organizes assets and liabilities into meaningful subgroups.

Question 20

Current vs. Long-Term Classification:

Answer 20

Current items are to be collected or owed within one year. Long-term items are expected after one year.

Question 21

Current Assets:

Answer 21

Assets to be sold, collected, or used within one year.

Ex. cash, short-term investments, accounts receivable, short-term notes receivable, merchandise, inventory, and prepaid expenses.

Question 22

Long-Term Investments:

Answer 22

Assets to be held for more than one year.

Ex. notes receivable, long-term investments in stocks and bonds, and land held for future expansion.

Question 23

Plant Assets:

Answer 23

Tangible assets used to produce or sell products and services.

Ex. equipment, machinery, buildings, and land used in operations.

Question 24

Intangible Assets:

Answer 24

Long-term assets that lack physical form.

Ex. patents, trademarks, copyrights, franchises, and goodwill.

Question 25

Current Liabilities:

Answer 25

Liabilities to be paid or settled within one year.

Ex. accounts payable, wages payable, taxes payable, interest payable, unearned revenues, and current portions of notes or long-term debt.

Question 26

Long-Term Liabilities:

Answer 26

Liabilities not due within one year.

Ex. notes payable, mortgages payable, bonds payable, and lease obligations.

Question 27

Equity:

Answer 27

The owner’s claim on assets.

For a corporation, this is common stock and retained earnings.

Question 28

Common Layout of a Classified Balance Sheet:

Answer 28

Assets Include:
Current assets, noncurrent assets, long-term investments, plant assets, intangible assets.

Liabilities and Equity Include:
Current liabilities, noncurrent liabilities, and equity.