Intermediate Accounting Chapter 2

Each economic event or transaction will have a dual effect on financial position. Explain what is mean by this dual effect.

According to the accounting equation, there is equality between the total economic resources of an entity, its assets, and the claims to those resources, liabilities, and equity. This implies that, since resources must always equal claims, the net effect of any transaction cannot affect one side of the accounting equation differently than the other side.

Define accrued liabilities. What adjusting journal entry is required to record accrued liabilities?

Accrued liabilities are recorded when an expense has been incurred that will not be paid until a subsequent reporting period. The adjusting entry required to record an accrued liability is a debit to an expense and a credit to a liability.

Describe how debits and credits affect assets, liabilities, and permanent owners' equity accounts.

Assets are increased by debits and decreased by credits. Liabilities and equity accounts are increased by credits and decreased by debits.

Explain the difference between external events and internal events. Give an example of each type of event.

External events involve an exchange transaction between the company and a separate economic entity. For every external transaction, the company is receiving something in exchange for something else. Internal events do not involve an exchange transaction but do affect the financial position of the company. Examples of external events are the purchase of inventory, a sale to a customer, and the borrowing of cash from a bank. Examples of internal events include the recording of depreciation expense, the expiration of prepaid rent, and the accrual of salary expense.

Describe how debits and credits affect temporary owners' accounts.

Revenues and gains are increased by credits and decreased by debits. Expenses and losses are increased by debits (thus causing owners' equity to decrease) and decreased by credits (thus causing owners' equity to increase).

Define reversing entries and discuss their purpose.

Reversing entries are recorded at the beginning of a reporting period. They remove the effects of some of the adjusting entries made at the end of the previous reporting period. This simplifies the journal entries made during the new period by *allowing cash payments or cash receipts to be entered directly into the expense or revenue account* without regard to the accrual made at the end of the previous period.

What adjusting entry is required at the end of a period to recognize the amount of deferred revenues that were recognized during the period?

The adjusting entry required when unearned revenues are earned is a debit to the unearned revenue liability and a credit to revenue.

What is the first step in the accounting processing cycle? What role do sources documents fulfill in this step?

The first step in the processing cycle is to identify external transactions affecting the accounting equation. Source documents, such as sales invoices, bills from suppliers, and cash register tapes, help to identify the transactions and then provide the information necessary to process the transaction.

Describe what is meant by transaction analysis.

The process of reviewing the source documents to determine the dual effect on the accounting equation and the specific elements involved.

Describe the purpose of the statement of comprehensive income and the statement of shareholders' equity.

- Statement of comprehensive income— reports the changes in shareholders' equity during the reporting period that were not a result of transactions with owners. This statement includes *net income* and also *other comprehensive income items*. - Statement of shareholders' equity— discloses the sources of the changes in the various permanent shareholders' equity accounts that occurred during the period. This statement includes changes resulting from investments by owners, distributions to owners, net income, and other comprehensive income.

Define adjusting entries and discuss their purpose.

Adjusting entries record the effect on financial position of internal events, those that do not involve an exchange transaction with another entity. They must be recorded at the end of any period when financial statements are prepared to properly reflect financial position and results of operations according to the accrual accounting model.

Describe what is meant by posting, the fourth step in the processing cycle.

After transactions are recorded in a journal, the debits and credits must be transferred to the appropriate general ledger accounts. This transfer is called posting.

What is an unadjusted trial balance? An adjusted trial balance?

An unadjusted trial balance is a list of the general ledger accounts and their balances at a time before any end-of-period adjusting entries have been recorded. An adjusted trial balance is prepared after adjusting entries have been recorded and posted to the accounts.

Define closing entries and their purpose.

Closing entries transfer the balances in the temporary owners' equity accounts to a permanent owners' equity account, retained earnings for a corporation. This is done only at the end of a fiscal year in order to reduce the temporary accounts to zero before beginning the next reporting year.

Explain the differences between permanent and temporary accounts. Why does an accounting system include both types of accounts?

Permanent accounts represent the financial position of a company—assets, liabilities and owners' equity—at a particular point in time. Temporary accounts represent the changes in shareholders' equity, the retained earnings component of equity for a corporation, caused by revenue, expense, gain, and loss transactions. It would be cumbersome to record revenue/expense, gain/loss transactions directly into the permanent retained earnings account. Recording these transactions in temporary accounts facilitates the preparation of the financial statements.

Explain the difference between the general ledger and a subsidiary ledger.

The general ledger is a collection of control accounts representing assets, liabilities, permanent and temporary shareholders' equity accounts. The subsidiary ledger contains a group of subsidiary accounts associated with a particular general ledger control account. For example, there will be a subsidiary ledger for accounts receivable that will keep track of the increases and decreases in the account receivable balance for each of the company's customers purchasing goods or services on credit. At any point in time, the balance in the accounts receivable control account should equal the sum of the balances in the accounts receivable subsidiary ledger accounts.

What is the purpose of a journal? What is the purpose of a general ledger?

The purpose of a journal is to capture, in chronological order, the dual effect of a transaction. A general ledger is a collection of storage areas called accounts. These accounts keep track of the increases and decreases in each element of financial position.

What is the purpose of special journals? In what ways do they simplify the recording process?

The purpose of special journals is to record, in chronological order, the dual effect of repetitive types of transactions, such as cash receipts, cash disbursements, credit sales, and credit purchases. Special journals simplify the recording process in the following ways: (1) journalizing the effects of a particular transaction is made more efficient through the use of specifically designed formats; (2) individual transactions are not posted to the general ledger accounts, but are accumulated in the special journals and a summary posting is made on a periodic basis; and (3) the responsibility for recording journal entries for the repetitive types of transactions is placed on individuals who have specialized training in handling them.