ACCT-Chapter 3 Adjusting Accounts and Preparing Financial Statements

contra account

Account linked with another account and having 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.

permanent accounts

Accounts that reflect activities related to one or more future periods; balance sheet accounts whose balances are not closed; also called real accounts.

temporary accounts

Accounts used to record revenues, expenses, and withdrawals (dividends for a corporation); they are closed at the end of each period; also called nominal accounts.

working papers

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

book value

Asset's acquisition costs less its accumulated depreciation (or depletion, or amortization); also sometimes used synonymously as the carrying value of an account.

time period assumption

Assumption that an organization's activities can be divided into specific time period such as months, quarters, or years.

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 are both unpaid and unrecorded; adjusting entries for recording accrued expenses involve increasing expense and increasing liabilities.

closing entries

Entries recorded at the end of each accounting period to transfer end-of-period balances in revenue, gain, expense, loss, and withdrawal (dividend for a corporation) accounts to the capital amount (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 at the end of an accounting period to bring an asset or liability account to its proper amount and update the related expense or revenue amount.

accounting period

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

unearned revenues

Liability created when customers pay in advance for products or services; earned when the products or services are later delivered.

adjusted trial balances

List of accounts and balances prepared after period-end adjustments are 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 assets (resources) used to produce or sell products or services; usually lack physical form and have uncertain benefits.

long-term investments

Long-term assets are not used in operating activities such as notes receivable and investments in stocks and bonds.

straight-line depreciation method

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

closing process

Necessary end-of period steps to prepare the accounts for recording the transactions of the next period.

operating cycle

Normal time between paying cash for merchandise or employee services and receiving cash from customers.

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.

expense recognition/matching principle

Prescribes expenses to be reported in the same period as the revenues that were earned as a result of the expenses.

profit margin

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

current ratio

Ratio used to evaluate a company's ability to pay its short-term obligations, calculated by dividing current assets by current liabilities.

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); adjusting entries for recording accrued revenues involve increasing assets and increasing revenues.

work sheet

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

pro forma financial statements

Statements that show the effects of proposed transactions and events as if they had occurred.

plant assets

Tangible long-lived assets used to produce or sell products and services; also called property, plant and equipment (PP&E) or fixed assets.

income summary

Temporary account used only in the closing process to which the balance 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).

natural business year

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