ACC 250 Exam

In completing the engagement in Question 4, Wilson pays no costs in March, $2,500 in April, and $2,200 in May (incurred in April). How much expense should the firm deduct from revenues in the month when it recognizes the revenue? Why?

Expenses of $4,700 should be deducted from the revenues in April. Under the expense recognition principle efforts (expenses) should be matched with results (revenues).

Why is it possible to prepare financial statements directly from an adjusted trial balance?

Financial statements can be prepared from an adjusted trial balance because the balances of all accounts have been adjusted to show the effects of all financial events that have occurred during the accounting period.

Indicate whether each account is an asset, a liability, or a stockholders' equity account, and whether it would have a normal debit or credit balance. a. Accounts Receivable. b. Accounts Payable. c. Equipment. d. Dividends. e. Supplies.

(a) Accounts Receivable—asset—debit balance. (b) Accounts Payable—liability—credit balance. (c) Equipment—asset—debit balance. (d) Dividends—stockholders' equity—debit balance. (e) Supplies—asset—debit balance.

For each of the following items before adjustment, indicate the type of adjusting entry—prepaid expense, unearned revenue, accrued revenue, and accrued expense—that is needed to correct the misstatement. If an item could result in more than one type of adjusting entry, indicate each of the types. a. Assets are understated. b. Liabilities are overstated. c. Liabilities are understated. d. Expenses are understated. e. Assets are overstated. f. Revenue is understated.

(a) Accrued revenues.. (b) Unearned revenues. (c) Accrued expenses. (d) Accrued expenses or prepaid expenses (e) Prepaid expenses. (f) Accrued revenues or unearned revenues.

. a. Define the terms assets, liabilities, and stockholders' equity. b. What items affect stockholders' equity?

(a) Assets are resources owned by a business. Liabilities are amounts owed to creditors. Put more simply, liabilities are existing debts and obligations. Stockholders' equity is the ownership claim on net assets. (b) The items that affect stockholders' equity are common stock, retained earnings, dividends, revenues, and expenses.

For each account listed here, indicate whether it generally will have debit entries only, credit entries only, or both debit and credit entries. a. Cash. b. Accounts Receivable. c. Dividends. d. Accounts Payable. e. Salaries and Wages Expense. f. Service Revenue.

(a) Cash—both debit and credit entries. (b) Accounts Receivable—both debit and credit entries. (c) Dividends—debit entries only. (d) Accounts Payable—both debit and credit entries. (e) Salaries and Wages Expense—debit entries only. (f) Service Revenue—credit entries only.

a. What are generally accepted accounting principles (GAAP)? b. What body provides authoritative support for GAAP?

(a) Generally accepted accounting principles (GAAP) are a set of rules and practices, having substantial support, that are recognized as a general guide for financial reporting purposes. (b) The body that provides authoritative support for GAAP is the Financial Accounting Standards Board (FASB).

How are each of the following financial statements interrelated? (a) Retained earnings statement and income statement. (b) Retained earnings statement and balance sheet. (c) Balance sheet and statement of cash flows.

(a) Net income from the income statement is reported as an increase to retained earnings on the retained earnings statement. (b) The ending amount on the retained earnings statement is reported as the retained earnings amount on the balance sheet. (c) The ending amount on the statement of cash flows is reported as the cash amount on the balance sheet.

a. Should accounting transaction debits and credits be recorded directly in the ledger accounts? b. What are the advantages of first recording transactions in the journal and then posting to the ledger?

(a) No, debits and credits should not be recorded directly in the ledger. (b) The advantages of using the journal are: (1) It discloses in one place the complete effect of a transaction. (2) It provides a chronological record of all transactions. (3) It helps to prevent or locate errors because the debit and credit amounts for each entry can be readily compared.

Which ratio or ratios from this chapter do you think should be of greatest interest to: a. a pension fund considering investing in a corporation's 20-year bonds? b. a bank contemplating a short-term loan? c. an investor in common stock?

(a) The debt to assets ratio and free cash flow indicate the company's ability to repay the face value of the debt at maturity and make periodic interest payments. (b) The current ratio and working capital indicate a company's liquidity and short-term debt-paying ability. (c) Earnings per share indicates the earning power (profitability) of an investment.

Holding all other factors constant, indicate whether each of the following signals generally good or bad news about a company. a. Increase in earnings per share. b. Increase in the current ratio. c. Increase in the debt to assets ratio. d. Decrease in free cash flow.

(a) The increase in earnings per share is good news because it means that profitability has improved. (b) An increase in the current ratio signals good news because the company improved its ability to meet maturing short-term obligations. (c) The increase in the debt to assets ratio is bad news because it means that the com¬pany has increased its obligations to creditors and has lowered its equity "buffer." (d) A decrease in free cash flow is bad news because it means that the company has become less solvent. The higher the free cash flow, the more solvent the company.

a. What is the primary objective of financial reporting? b. Identify the characteristics of useful accounting information.

(a) The primary objective of financial reporting is to provide information useful for decision making. (b) The fundamental qualitative characteristics are relevance and faithful representation. The enhancing qualities are comparability, consistency, verifiability, timeliness, and understandability.

What do these classes of ratios measure? a. Liquidity ratios. b. Profitability ratios. c. Solvency ratios.

9. (a) Liquidity ratios measure the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash. (b) Profitability ratios measure the income or operating success of a company for a given period of time. (c) Solvency ratios measure the company's ability to survive over a long period of time.

a. What is a ledger? b. Why is a chart of accounts important?

A record of all accounts maintained by a company and their accounts, including all the asset, liability, and stockholders' equity accounts, is referred to collectively as the ledger. (b) The chart of accounts is important, particularly for a company that has a large number of accounts, because it helps organize the accounts and identify their location in the ledger.

What is a trial balance and what are its purposes?

A trial balance is a list of accounts and their balances at a given time. The primary purpose of a trial balance is to prove the mathematical equality of debits and credits after all journalized trans¬actions have been posted. A trial balance also facilitates the discovery of errors in journalizing and posting. In addition, it is useful in preparing financial statements.

Are the following events recorded in the accounting records? Explain your answer in each case. a. A major stockholder of the company dies. b. Supplies are purchased on account. c. An employee is fired. d. The company pays a cash dividend to its stockholders.

Accounting transactions are the economic events of the company recorded by accountants because they affect the basic accounting equation. (a) The death of a major stockholder of the company is not an accounting transaction as it does not affect the basic accounting equation. (b) Supplies purchased on account is an accounting transaction because it affects the basic accounting equation. (c) An employee being fired is not an accounting transaction as it does not affect the basic accounting equation. (d) Paying a cash dividend to stockholders is an accounting transaction as it does affect the basic accounting equation.

What are the advantages to a business of being formed as a corporation? What are the disadvantages?

Advantages of a corporation are limited liability (stockholders not being personally liable for cor¬porate debts), easy transferability of ownership, and ease of raising funds. Disadvantages of a corporation are increased taxation and government regulations.

Why is it important for financial statements to receive an unqualified auditor's opinion?

An unqualified opinion shows that, in the opinion of an independent auditor, the financial state¬ments have been presented fairly, in conformity with generally accepted accounting principles. This gives investors more confidence that they can rely on the figures reported in the financial statements.

What is the basic accounting equation?

Assets = Liabilities + Stockholders' Equity.

Define current assets. What basis is used for ordering individual items within the current assets section?

Current assets are assets that a company expects to convert to cash or use up within one year of the balance sheet date or the company's operating cycle, whichever is longer. Current assets are listed in the order in which they are expected to be converted into cash.

How do current liabilities differ from long-term liabilities?

Current liabilities are obligations that will be paid within the coming year or operating cycle, whichever is longer. Long-term liabilities are obligations that will be paid after one year.

. Explain the differences between depreciation expense and accumulated depreciation.

Depreciation expense is an expense account whose 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.

"An adjusting entry may affect more than one balance sheet or income statement account." Do you agree? Why or why not

Disagree. An adjusting entry affects only one balance sheet account and one income statement account.

The terms debit and credit mean "increase" and "decrease," respectively. Do you agree? Explain.

Disagree. The terms debit and credit are synonymous with left and right, respectively.

Explain the terms earnings management and quality of earnings.

Earnings management is the planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income. Such action is undertaken to help a company meet target financial numbers. Quality of earnings indicates the level of full and transparent information that a company provides to users of financial statements.

What types of information are presented in the notes to the financial statements?

Information included in the notes to the financial statements clarifies information presented in the financial statements and includes descriptions of accounting policies, explanations of uncertain¬ties and contingencies, and statistics and details too voluminous to be reported in the financial statements.

Distinguish between long-term investments and property, plant, and equipment.

Long-term investments are investments in stocks and bonds of other companies where the conversion into cash is not expected within one year or the operating cycle, whichever is longer, and plant assets not currently in operational use. Property, plant, and equipment are tangible resources of a relatively permanent nature that are being used in the business and not intended for sale.

Misty Reno, a beginning accounting student, believes debit balances are favorable and credit balances are unfavorable. Is Misty correct? Discuss.

Misty is incorrect. A debit balance only means that debit amounts exceed credit amounts in an account. Conversely, a credit balance only means that credit amounts are greater than debit amounts in an account. Thus, a debit or credit balance is neither favorable or unfavorable.

"Depreciation is a process of valuation 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. Depreciation results in the presentation of the book value of the asset, not its fair value.

What is retained earnings? What items increase the balance in retained earnings? What items decrease the balance in retained earnings?

Retained earnings is the net income retained in a corporation. Retained earnings is increased by net income and is decreased by dividends and a net loss.

What are the basic steps in the recording process?

The basic steps in the recording process are: (1) Analyze each transaction in terms of its effect on the accounts. (2) Enter the transaction information in a journal. (3) Transfer the journal information to the appropriate accounts in the ledger.

Why may the financial information in an unadjusted trial balance not be up-to-date and complete?

The financial information in a trial balance may not be up-to-date because: (1) Some events are not journalized daily because it is not useful or efficient to do so. (2) The expiration of some costs occurs with the passage of time rather than as a result of recurring daily transactions. (3) Some items may be unrecorded because the transaction data are not known.

What are the five steps of the revenue recognition process

The five steps of the revenue recognition process are: Step 1: Identify the contract with customers. Step 2: Identify the separate performance obligations in the contract. Step 3: Determine the transaction price. Step 4: Allocate the transaction price to the separate performance obligations. Step 5: Recognize revenue when each performance obligation is satisfied.

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

The law firm should recognize the revenue in April. The revenue recognition principle states that revenue should be recognized in the accounting period in which the performance obligation is satisfied.

What is the primary purpose of the statement of cash flows?

The primary purpose of the statement of cash flows is to provide financial information about the cash receipts and cash payments of a business for a specific period of time.

What is the purpose of the management discussion and analysis section (MD&A)?

The purpose of the management discussion and analysis section is to provide management's views on its ability to pay short-term obligations, its ability to fund operations and expansion, and its results of operations. The MD&A section is a required part of the annual report.

Identify and state two generally accepted accounting principles that relate to adjusting the accounts.

The revenue recognition principle, which states that revenue should be recognized in the time period in which the performance obligation is satisfied. The expense recognition principle, which states that expenses be matched with revenues in the period when the company makes efforts to generate those revenues.

What are the three main types of business activity? Give examples of each activity.

The three types of business activities are financing activities, investing activities, and operating activities. Financing activities include borrowing money and selling shares of stock. Investing activities include the purchase and sale of property, plant, and equipment. Operating activities include selling goods, performing services, and purchasing inventory.

Identify the two parts of stockholders' equity in a corporation and indicate the purpose of each.

The two parts of stockholders' equity and the purpose of each are: (1) Common stock is used to record investments of assets in the business by the owners (stockholders) and (2) Retained earnings is used to record net income retained in the business.

Give examples of how companies manage earnings.

Use of "one-time" items to prop up earnings numbers. A company may decide to sell property that has appreciated in value in order to record a gain on the sale. Such a gain will increase the current year's net income but future income will probably not include a similar increase. Inflating revenue in the short-run to the detriment of the long-run. A company may implement changes in its promotion activities near the end of an accounting period to boost year-end revenues. Offering a special rebate or a two-for-one package is likely to increase sales for the time the promotion runs but usually results in lower sales in subsequent periods. Savvy customers may even postpone purchases until special deals are available. Recording improper adjusting entries. Some adjusting entries require estimates and judgment to properly recognize revenue and match expenses. By recognizing revenue "sooner" and delaying the recognition of expenses, earnings can be overstated in early periods and understated in subsequent periods. This type of management is most prevalent with multi-year contracts and prepaid expenses.

Can a business enter into a transaction that affects only the left side of the basic accounting equation? If so, give an example.

Yes, a business can enter into a transaction in which only the left side of the accounting equation is affected. An example would be a transaction where an increase in one asset is offset by a decrease in another asset. An increase in the equipment account which is offset by a decrease in the cash account is a specific example.