concepts in chapter 4

Question 1

What is a fiscal year

Answer 1

An accounting time period that is one year long.

Question 2

What is Revenue recognition principle

Answer 2

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

Question 3

Expense recognition principle (matching principle)

Answer 3

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

Question 4

In recognizing expenses, a simple rule is followed:

Answer 4

“Let the expenses follow the revenues.”

Question 5

What is Accrual-basis accounting

Answer 5

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

Question 6

What is Cash-basis accounting

Answer 6

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).

Question 7

What are Adjusting entries

Answer 7

Entries made at the end of an accounting period to ensure that the revenue recognition and expense recognition principles are followed.

Question 8

Prepaid expenses:

Answer 8

Expenses paid in cash before they are used or consumed. This is a deferral. Example paying car insurance for next year

Question 9

Unearned revenues:

Answer 9

Cash received before services are performed. This is a deferral. Example owner of commercial airline. Ticket is paid for but not used till later.

Question 10

Accrued revenues:

Answer 10

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.

Question 11

Accrued expenses:

Answer 11

Expenses incurred but not yet paid in cash or recorded. This is an accrual. Example water bill paid quarterly. $50 used each month (expenses).

Question 12

Depreciation

Answer 12

The process of reducing the book value of a tangible fixed asset due to use, wear and tear, the passing of time, or obsolescence.

Question 13

accumulated depreciation

Answer 13

a contra asset account (think of the oven example)

Question 14

closing entries

Answer 14

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.

Question 15

Red Ale (is an account permanent or temporary)

Answer 15

Temporary accounts are red - revenue, expenses, dividends. Permanent accounts are ale - assets, liabilities, equity

Question 16

Permanent account (real account)

Answer 16

The balance at the end of an accounting period is always carried forward into the next one. They live in the general ledger.

Question 17

Temporary account

nominal account

Answer 17

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.

Question 18

income summary account

Answer 18

very temporary account used when closing entries.

Question 19

Contra asset account

Answer 19

An account that is offset against an asset account on the balance sheet.

Question 20

what is the normal balance of a contra asset account

Answer 20

credit

Question 21

Why is using a contra asset account preferable?

Answer 21

It discloses both the original cost of the equipment and the total cost that has expired to date.

Question 22

what is over or understated before adjustment of unearned revenue

Answer 22

Liabilities overstated.

Revenues understated.

Question 23

What is over or understated before adjustment of prepaid expenses?

Answer 23

Assets overstated.

Expenses understated.

Question 24

adjusting entry for accruals will

Answer 24

increase both a balance sheet and an income statement account.

Question 25

an adjusting entry for prepaid expenses results in

Answer 25

an increase (a debit) to an expense account and a decrease (a credit) to an asset account.

Question 26

the adjusting entry for unearned revenues results in

Answer 26

a decrease (a debit) to a liability account and an increase (a credit) to a revenue account.

Question 27

The accrual of unrecorded service revenue

Answer 27

increases an asset account, Accounts Receivable. It also increases stockholders’ equity by increasing a revenue account

Question 28

Equation analyses summarize the effects of transactions on which three elements of the accounting equation, as well as the effect on cash flows.

Answer 28

assets, liabilities, stockholders equity

Question 29

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

Answer 29

understated.

Question 30

the adjusting entry for accrued revenues results in

Answer 30

Assets understated.

Revenues understated.

Question 31

an adjusting entry for accrued expenses results in

Answer 31

an increase (a debit) to an expense account and an increase (a credit) to a liability account.

Question 32

formula for computing interest

Answer 32

face value of note x annual interest rate x time in terms of one year (1/12)

Question 33

Without this adjusting entry in accrued expenses,

Answer 33

liabilities and interest expense are understated, and net income and stockholders’ equity are overstated.

Question 34

What is over or understated before adjustment of accrued expenses?

Answer 34

Expenses understated.

Liabilities understated.

Question 35

what is the adjusting entry for prepaid expenses

Answer 35

Dr. expenses

Cr. assets or contra assets

Question 36

what is the adjusting entry for unearned revenues

Answer 36

Dr. liabilities

Cr. revenues

Question 37

what is the adjusting entry for accrued revenues

Answer 37

Dr. assets

Cr. revenues

Question 38

what is the adjusting entry for accrued expenses

Answer 38

Dr. expenses

Cr. liabilities

Question 39

trial balance

Answer 39

an accounting report showing the closing balances of all general ledger accounts at a point in time.

Question 40

Adjusted trial balance

Answer 40

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

Question 41

what is the primary basis for the preparation of financial statements.

Answer 41

adjusted trial balance

Question 42

Earnings management

Answer 42

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

Question 43

Quality of earnings

Answer 43

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

Question 44

Ways companies manage earnings

Answer 44

• one time items to prop up earnings
• inflate revenue
• improper adjusting entries

Question 45

Reversing entry

Answer 45

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

Question 46

Steps in the accounting cycle

Answer 46

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