Chapter 3: Adjusting Accounts for Financial Statements

Contra Account

Account linked with another account that has an opposite normal balance; reported as a subtraction from the other account's balance.

Cash Basis Accounting

Accounting system that recognizes revenues when cash is received and records expenses when cash is paid.

Accrual Basis Accounting

Accounting system that recognizes revenues when earned and expenses when incurred; the basis for GAAP.

Temporary Accounts (Nominal)

Accounts that are opened at the beginning of an accounting period, used to record transactions and events for that period, and then closed at the end of the period.

Permanent Accounts

Accounts that reflect activities related to one or more future periods. They carry their ending balances into the next period.

Book Value

An asset's cost less its accumulated depreciation.

Working Papers

Analyses and other informal reports prepared by accountants and managers when organizing information for formal reports and financial statements.

Long - Term Investments

Assets not used in operating activities, and expected to be held for more than one year or operating cycle, whichever is longer.

Unclassified Balance Sheet

Balance sheet that broadly groups assets, liabilities, and equity accounts.

Classified Balance Sheet

Balance sheet that presents assets and liabilities in relevant subgroups, including current and noncurrent classifications.

Current Assets

Cash and other assets expected to be sold, collected, or used within one year or the company's operating cycle, whichever is longer.

Fiscal Year

Consecutive 12-month (or 52-week) period chosen as the organization's annual accounting period.

Accrued Expenses

Costs incurred in a period that have not been paid or recorded.

Closing Entries

Entries recorded at the end of each accounting period to transfer end-of-period balances in revenue, gain, expense, loss, and withdrawal (or dividend for a corporation) accounts to the capital account (or to retained earnings for a corporation).

Depreciation

Expense created by allocating the cost of plant and equipment to periods in which they are used; represents the expense of using the asset.

Annual Financial Statements

Financial statements covering a one-year period; often based on a calendar year, but any consecutive 12-month (or 52-week) period is acceptable.

Interim Financial Statements

Financial statements covering periods of less than one year; usually based on one-, three-, or six-month periods.

Prepaid Expenses

Items paid for in advance of receiving their benefits; classified as assets.

Adjusting Entry

Journal entry made at the end of an accounting period to reflect a transaction or event that is not yet recorded and bring an asset or liability account to its proper amount and update the related expense or revenue account.

Accounting Period

Length of time covered by financial statements; also called reporting period.

Adjusted Trial Balance

List of accounts and balances prepared after period-end adjusting entries have been recorded and posted.

Unadjusted Trial Balance

List of accounts and balances prepared before accounting adjustments are recorded and posted.

Post - Closing Trial Balance

List of permanent accounts and their balances from the ledger after all closing entries are journalized and posted.

Intangible Assets

Long - term resources or assets that benefit business operations, usually lack physical form, and have uncertain benefits.

Straight - Line Depreciation Method

Method that allocates an equal portion of the depreciable cost of plant asset (cost minus salvage) to each accounting period in its useful life.

Closing Process

Necessary end-of-period steps (that take place after financial statements have been completed) to prepare the accounts for recording the transactions of the next period.

Current Liabilities

Obligations due to be paid or settled within one year or the company's operating cycle, whichever is longer.

Long - Term Liabilities

Obligations not due to be paid within one year or the operating cycle, whichever is longer.

Reversing Entries

Optional entries recorded at the beginning of a period that prepare the accounts for the usual journal entries as if adjusting entries had not occurred in the prior period.

Profit Margin = Net Income / Net Sales

Ratio of a company's net income to its net sales; the percent of income in each dollar of revenue.

Current Ratio = Current Assets / Current Liabilities

Ratio used to evaluate a company's ability to pay its short-term obligations.

Accounting Cycle

Recurring steps performed each accounting period, starting with analyzing transactions and continuing through the post-closing trial balance (or reversing entries).

Accrued Revenues

Revenues earned in a period that are both unrecorded and not yet received in cash (or other assets).

Worksheet

Spreadsheet used to draft an unadjusted trial balance, adjusting entries, adjusted trial balance, and financial statements.

Plant Assets

Tangible long-lived assets used to produce or sell products and services. Also called fixed assets.

Income Summary

Temporary account used only in the closing process to which the balances of revenue and expense accounts (including any gains or losses) are transferred; its balance is transferred to the capital account (or retained earnings for a corporation).

Operating Cycle

The time span from when cash is used to acquire goods and services (such as merchandise or employee services) until cash is received from the sale of goods and services. (from customers)

Natural Business Year

Twelve-month period that ends when a company's sales activities are at their lowest point.