Section 1 - Why we use accruals, deferrals and other adjustments

Question 1

A Deferral takes place when?

Answer 1

There has been a PREPAYMENT of cash.

The company receives prepayment from a customer for services or goods that will be provided in the future.

OR

The company prepays a future expense such as Insurance or Rent.

Question 2

Your bookkeeping company performed services for client ABC, however, payment has not been received.

This is an example of:

Answer 2

Accrued Revenue - (Revenue earned*, but not yet received)

*A company has earned revenue when the service has been provided or goods have been sold.

Question 3

On December 1, 20X1, your consulting firm received an $11,000 advance for work that will be performed in January 20X2.

This is an example of:

Answer 3

Deferred (Unearned) Revenue - (Prepayment from a customer before the service has been provided or goods have been sold)

When recording transactions using the accrual basis and in accordance with the GAAP ‘revenue recognition’ principle, revenue cannot be recognized unless it has been earned, therefore, Deferred ‘Unearned’ Revenue creates a liability until the company provides the service or sells the goods.

Question 4

Perry CO received their Verizon telephone bill for the month of April, however, payment will be made in June.

This is an example of:

Answer 4

Accrued Expense - (Expense incurred, but not yet paid)

When recording transactions using the accrual basis of accounting, and in accordance with the GAAP ‘matching principle,’ expenses must be recognized when they have been incurred. The term incurred denotes when resources have been used up (supplies), consumed (rent) or expired (insurance).

Question 5

Adjusting entries are generally recorded at the _____ of the year.

Answer 5

END of the year or any other accounting period.

Question 6

Adjusting entries involve the cash account.

True or False

Answer 6

False. The Cash account is never adjusted.

Should a company need to record the interest earned on an interest bearing account, such as a money market, the increase in cash and revenue is not considered an adjusting entry, instead it is regarded as a normal transactional entry.

Question 7

When recording journal entries for accrued revenue and accrued expenses, the two accounts to think of are:

Answer 7

Accounts Receivable (unpaid revenues)

and

Accounts Payable (outstanding expenses)

Question 8

GAAP stands for?

Answer 8

Generally Accepted Accounting Principles.

GAAP is a collection of commonly-followed accounting rules and the standard framework of guidelines for financial accounting.

Question 9

Under the cash basis of accounting, expenses are recognized when?

Answer 9

Under the cash basis method of accounting, expenses are not recorded unless they have been paid.

Question 10

If total revenues are higher than total expenses, the business has ________.

Answer 10

Net income.

Revenue - $ 3,000

Expenses- 2,600

Net Income- $ 400 (reported on Income Statement)

Question 11

Under the accrual basis of accounting, revenue is recognized when?

Answer 11

Revenue is recognized under the accrual basis when it has been earned. Under the accrual basis of accounting, the exchange of cash is IRRELEVANT. Revenue is considered earned when the service has been provided or goods have been sold with no regard to whether or not cash has been received

Question 12

Under the ______ basis method of accounting, the physical exchange of cash is Irrelevant.

Answer 12

Accrual

Under the accrual basis method of accounting, Revenue is considered earned when the service has been provided or goods have been sold with no regard to whether or not cash has been received.

Question 13

On September 1st, your consulting firm prepaid $36,000 for a two-year Insurance premium.

This is an example of:

Answer 13

Deferred (Prepaid) Expense - (Prepayment by a company for a future expense)

The term deferred expense refers to delaying or postponing the reporting of an expense until a later accounting period when it expires (insurance) or is used up (supplies). When a company pays for an expense in advance, this requires the company to recognize a prepaid asset on the books, reflecting the future value of the prepaid expense.

Question 14

The two main types of adjusting entries are?

Answer 14

Accruals and Deferrals

Question 15

Adjusting entries involve both a balance sheet and income statement account.

True or False

Answer 15

True

Adjusting entries almost always involve a Balance sheet account (Interest Payable, Prepaid Insurance, Accounts Receivable, etc.) and an Income statement account (Interest Expense, Insurance Expense, Service Revenues, etc.)

Adjusting entries assure that both the Balance sheet and the Income statement are up-to-date and in accordance with the accrual basis of accounting

Question 16

An Accrual takes place when?

Answer 16

Accrued Revenue - A company has provided services or goods to a customer, however, payment has not been received. (Accounts Receivable)

OR

Accrued Expense - A company has incurred an expense, however, payment has not yet been made. (Accounts Payable)

Question 17

If total expenses are higher than total revenue, the business has a ________.

Answer 17

Net loss.

Revenue - $ 1,800

Expenses- 2,900

Net Loss- $ 1,100 (reported on Income Statement)

Question 18

The _______ basis method of accounting is required by GAAP.

Answer 18

Accrual.

Under GAAP, it is prohibited to record an incoming payment unless it has been earned. Likewise, expenses must be reported in the period in which they were incurred, even if they were not paid.

Question 19

What is the purpose of adjusting entries?

Answer 19

Recognize revenues in the accounting period, they were earned.
(Revenue recognition principle).

Recognize expenses in the period, they were incurred.

(Matching principle).