Chapter 3 Q&A

Why do accrual basis financial statements provide more useful information than cash basis statements?

Accruals basis reveals relationships that are likely to be important in predicting future results. I.e. Revenues are recognized when the performance obligation is satisfied so they can be related to the economic environment in which they occur. Trends in revenue are then more useful.

What are the 4 types of adjusted trial balance entries?

Accrued Expense, Accrued Revenue, Prepaid Expense, Deferred Revenue

How does the time period assumption affect accountants analysis of business transactions?

An accountant is required to determine the relevance of each business transaction to specific accounting periods

What are the 10 steps in the accounting cycle?

Analyze transactions Journal entries Post to ledgers Trial balance Adjusting entries Adjusted trial balance Income statement Statement of owners equity Balance sheet Statement of cash flows

Why may a trial balance not contain up to date and complete financial information?

Because... 1) some events are not journalized daily because it is not efficient to do so. 2) The expiration of some costs occurs with the passage of time rather than a result of daily transactions. 3) some items may not be recorded because the transactional data is not yet known.

Explain the difference between depreciation expense and accumulated depreciation.

Depreciation Expense is an expense account where normal balance is a debit. This account shows the cost that has expired during the current accounting period. Accumulated depreciation is a contra asset account whose normal balance is a credit. The balance in this account is the depreciation that has been recognized from the date of acquisition to the balance sheet date.

A company purchased equipment for $18,000. By the current balance sheet date, $6000 had been depreciated. Indicate the balance sheet presentation of the data.

Equipment $18,000 - accumulated depreciation -$6000 ------------- $12,000

What is the formula to find the book value?

Equipment - accumulated depreciation = book value

True or false: accountants divide the economic life of a business into artificial time periods, but each transaction affects only one of these periods.

False

What is the debit or credit affect of an unearned revenue adjusting entry?

In the adjusting entry on earned revenue is a liability and is debited and a revenue is credited.

Do adjusted trial balance entries include cash?

No

Adjusting entries are required by the historical cost principle of accounting. Do you agree? Why?

No, adjusting entries are required by the revenue recognition and expense recognition principles

Depreciation is a valuation process that results in the reporting of the fair value of the asset. Do you agree? Explain

No, depreciation is the process of allocating the cost of an asset to expense over its useful life in a rational and systemic manner. Depreciation results in the presentation of the book value of the asset, not it's fair value.

Depreciation is NOT what?

Not a valuation method and not a cash replacement fund

Define 2 GAAP that relate to adjusting the accounts

Revenue recognition principle and expense recognition principle

What is the debit or credit affect of a prepaid expense adjusting entry?

The expense is debited and the asset is credited.

A company fails to recognize an expense incurred but not paid. Indicate which account is debited and which is credited in the adjusting entry

The expenses debited and the liability is credited in the adjusting entry

A lawyer accepts a legal engagement in march, performs the work in April, and is paid in May. If the law firm prepares monthly financial statements, when should it recognize revenue from this engagement? Why?

The law firm should recognize the revenue in April. Revenue recognition principle states that revenue should be recognized in the accounting period in which services are performed.

A company makes an accrued revenue adjusting entry for $900. And accrued expenses adjusting entry for $700. How much was the net income understated prior to these entries? Explain

The net income was understated by $200 because prior to the adjustment, revenues are understated by $900 and expenses understated by $700 the difference in this case is $200.

A company fails to recognize revenue for services performed but not yet received in cash or recorded. Which accounts are involved in the adjusting entry? Indicate which one is debited and which one is credited.

The two accounts are asset and revenue. The asset would be debited and the revenue would be credited.

Distinguish between the categories of adjusting entries, and identify the types of adjustments applicable to each category

The two categories are deferrals and accruals. deferrals consist of prepaid expenses and unearned revenues. Accruals consist of accrued revenues and accrued expenses.

True or false: accounting time periods are generally a month, quarter or a year

True

True or false: adjusting entries would not be necessary if a companies life were not divided into artificial time periods?

True

True or false: the IRS requires companies to file annual tax returns?

True, cash basis accounting

What does a deferred revenue entry look like?

Unearned revenue ______________ revenue

What does a prepaid expense look like?

__________ expense Asset or contra asset

What does an Accrued Expense entry look like?

__________ expense __________ payable

What does an Accrued revenue entry look like ?

__________ receivable __________ revenue