Topic 5 - Accrual Accounting Concepts

Question 1

What is cash-based accounting?

Answer 1

Revenue recognised when the cash is received.

Expenses recognised when the cash is paid.

Question 2

What is accrual-based accounting?

Answer 2

Revenues are recognised when goods and services are provided.
Expenses are recognised when assets are consumed or liabilities incurred.

Question 3

Explain the criteria for revenue recognition.

Answer 3

• Accounting period assumption
• Conceptual framework provides guidance where revenues should be recognised when a. it is probable that any future economic benefits associated with the revenue will flow to the entity; and,
  b. the revenue can be measured with reliability.

Question 4

Explain the criteria for expense recognition.

Answer 4

• Expenses are decreases in economic benefits (decreases in equity which aren’t due to distributions to the owner/s)
• Conceptual framework provides guidance where
  expenses should be recognised when and only when: a. the outflow of future economic benefits associated with the expense is probable; and,
  b. the expense can be measured reliably.

Question 5

Why are adjusting entries needed?

Answer 5

Adjusting entries are necessary each time financial statements are prepared to make sure:

• Revenues and expenses are recorded in the correct accounting period (accounting period concept).
• Recognition criteria are followed for assets, liabilities, revenues and expenses (conceptual framework criteria).

Question 6

What are the major types of adjusting entries?

Answer 6

Prepayments:

• Prepaid Expenses
• Revenue Received in Advance

Accruals:

• Accrued Revenues
• Accrued Expenses

Question 7

What is the nature and purpose of the adjusted trial balance?

Answer 7

• prepared after all adjusting entries have been made.
• It is used to prove the equality of total debit balances and total credit balances after the adjusting entries have been made.

Question 8

What is the purpose of closing entries?

Answer 8

Closing entries are used to transfer the temporary account balances to the permanent equity account, retained earnings.

• produce a zero balance in each temporary account

Question 9

Describe the required steps in the accounting cycle.

Answer 9

1. Analyse transactions
2. Journalise transactions
3. Post to ledger accounts
4. Prepare trial balance
5. Journalise and post adjusting entries: prepayments/accruals
6. Prepare adjusted trial balance
7. Prepare financial statements
8. Journalise and post closing entries
9. Prepare post-closing trial balance

Question 10

Describe the purpose and basic form of a worksheet.

Answer 10

Worksheets are spreadsheets prepared either manually or electronically to assist in the preparation of the adjusting entries and the preparation of the financial statements.

Question 11

What do revenue and expense criteria form?

Answer 11

Part of generally accepted accounting principles (GAAP)

Question 12

What do adjusting entries affect?

Answer 12

• A statement of financial position account
• A statement of profit or loss account

NEVER INVOLVES CASH

Question 13

What steps are required when preparing financial statements?

Answer 13

• Statement of profit and loss prepared from revenue and expense accounts
• Current period profit or loss and dividends paid transferred to Retained Profits account
• Statement of Financial Position prepared from asset, liability, equity and balance of retained earnings account

Question 14

What are temporary accounts?

Answer 14

relate to only a given accounting period:

i.e. revenues, expenses, dividends.

Question 15

What are permanent accounts?

Answer 15

are carried forward to future accounting periods:

i.e. assets, liabilities, equity.

Question 16

When preparing closing entries what steps are required?

Answer 16

1. Revenue and expense accounts closed to Income Summary account
2. Income Summary account closed to Retained Earnings
3. Dividends closed to Retained Earnings

Question 17

What is the purpose of a post-closing trial balance?

Answer 17

The purpose of the post-closing trial balance is to prove the equality of the permanent accounts that are carried forward to the next accounting period.

Question 18

What are some unethical opportunities that accrual accounting provides? *

Answer 18

A dishonest businessperson could omit depreciation expense at the end of the year.
Failing to record depreciation would overstate profit as calculated by mandated accrual principles and disclose a more favourable picture of the business’ financial position than actually existed.
Some accruals are based on estimates, such as depreciation and revenue, and these can be manipulated.