concepts in chapter 4 Flashcards
What is a fiscal year
An accounting time period that is one year long.
What is Revenue recognition principle
The principle that companies recognize revenue in the accounting period in which the performance obligation is satisfied.
Expense recognition principle (matching principle)
The principle that matches expenses with revenues in the period when the company makes efforts to generate those revenues.
In recognizing expenses, a simple rule is followed:
“Let the expenses follow the revenues.”
What is Accrual-basis accounting
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
What is Cash-basis accounting
Accounting basis in which a company records revenue only when it receives cash and an expense only when it pays cash. Cash-basis accounting is NOT in accordance with generally accepted accounting principles (GAAP).
What are Adjusting entries
Entries made at the end of an accounting period to ensure that the revenue recognition and expense recognition principles are followed.
Prepaid expenses:
Expenses paid in cash before they are used or consumed. This is a deferral. Example paying car insurance for next year
Unearned revenues:
Cash received before services are performed. This is a deferral. Example owner of commercial airline. Ticket is paid for but not used till later.
Accrued revenues:
Revenues for services performed but not yet received in cash or recorded. This is an accrual. Example of owning software company. You do the work in one month and bill in the next.
Accrued expenses:
Expenses incurred but not yet paid in cash or recorded. This is an accrual. Example water bill paid quarterly. $50 used each month (expenses).
Depreciation
The process of reducing the book value of a tangible fixed asset due to use, wear and tear, the passing of time, or obsolescence.
accumulated depreciation
a contra asset account (think of the oven example)
closing entries
Journal entries posted at the end of an accounting period to reset temporary accounts to zero. The balances are transferred to a permanent account called retained earnings.
Red Ale (is an account permanent or temporary)
Temporary accounts are red - revenue, expenses, dividends. Permanent accounts are ale - assets, liabilities, equity
Permanent account (real account)
The balance at the end of an accounting period is always carried forward into the next one. They live in the general ledger.
Temporary account
nominal account
The closing balance at the end of the accounting period always needs to be reset to zero. They also belong to the accounting ledger but only apply to one period.
income summary account
very temporary account used when closing entries.
Contra asset account
An account that is offset against an asset account on the balance sheet.
what is the normal balance of a contra asset account
credit
Why is using a contra asset account preferable?
It discloses both the original cost of the equipment and the total cost that has expired to date.
what is over or understated before adjustment of unearned revenue
Liabilities overstated.
Revenues understated.
What is over or understated before adjustment of prepaid expenses?
Assets overstated.
Expenses understated.
adjusting entry for accruals will
increase both a balance sheet and an income statement account.
an adjusting entry for prepaid expenses results in
an increase (a debit) to an expense account and a decrease (a credit) to an asset account.
the adjusting entry for unearned revenues results in
a decrease (a debit) to a liability account and an increase (a credit) to a revenue account.
The accrual of unrecorded service revenue
increases an asset account, Accounts Receivable. It also increases stockholders’ equity by increasing a revenue account
Equation analyses summarize the effects of transactions on which three elements of the accounting equation, as well as the effect on cash flows.
assets, liabilities, stockholders equity
in accrued revenues, Without the adjusting entry, assets and stockholders’ equity on the balance sheet and revenues and net income on the income statement are
understated.
the adjusting entry for accrued revenues results in
Assets understated.
Revenues understated.
an adjusting entry for accrued expenses results in
an increase (a debit) to an expense account and an increase (a credit) to a liability account.
formula for computing interest
face value of note x annual interest rate x time in terms of one year (1/12)
Without this adjusting entry in accrued expenses,
liabilities and interest expense are understated, and net income and stockholders’ equity are overstated.
What is over or understated before adjustment of accrued expenses?
Expenses understated.
Liabilities understated.
what is the adjusting entry for prepaid expenses
Dr. expenses
Cr. assets or contra assets
what is the adjusting entry for unearned revenues
Dr. liabilities
Cr. revenues
what is the adjusting entry for accrued revenues
Dr. assets
Cr. revenues
what is the adjusting entry for accrued expenses
Dr. expenses
Cr. liabilities
trial balance
an accounting report showing the closing balances of all general ledger accounts at a point in time.
Adjusted trial balance
A list of accounts and their balances after all adjustments have been made.
what is the primary basis for the preparation of financial statements.
adjusted trial balance
Earnings management
The planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income.
Quality of earnings
Indicates the level of full and transparent information that a company provides to users of its financial statements.
Ways companies manage earnings
- one time items to prop up earnings
- inflate revenue
- improper adjusting entries
Reversing entry
An entry made at the beginning of the next accounting period; the exact opposite of the adjusting entry made in the previous period.
Steps in the accounting cycle
Analyze business transactions, journalize the transactions, post to ledger accounts, prepare a trial balance, journalize and post adjusting entries deferrals and accruals, prepare an adjusted balance, prepare financial statements: income statement, retained earnings statement, balance sheet, journalize and post closing entries, prepare a post-closing trial balance
