Chapter 3 A201

Accrual Basis Accounting

revenue are recognized when they are earned and expenses when they are incurred to generate revenue (required by GAAP) A company must recognize revenue when the company transfers promised goods or services to customers and in the amount it expects to be entitled to receive

1. What issues arise that accountants must address in reporting periodic income to external users?

-Measuring issues: What amounts should be recognized? -Recognition issues: When should the effects of operation activities be recognized?

16. In May, Sea the World Cruises, Inc. collected $1,000 cash from a customer for services to be performed in June. Which of the following is true assuming accrual accounting?

1000 revenue recorded in June

13. Accruix, Inc. uses accrual basis accounting. Its balance sheets reported Accounts Receivable of $5,000 at the end of its first year of business. Its income statement reported Sales Revenue of $100,000 for its first year. What would Accruix's revenues have been if it had used cash basis accounting?

95,000

5. Reporting revenues only when cash is received and expenses only when cash is paid is called the__ basis accounting.

Cash

15. Companies that fail to meet investors' expectations often experience a

Decrease in stock prices

Expenses

Decrease net income and SE. Debits go UP Accounts have debit balances

8. Identify which line items are a result of peripheral transactions (i.e., those not central to on-going operations) and, thus, are listed below operating income on a multiple step income statement.

Investment Expense Investment Income (revenue, dividend revenue)

11. What issues arise that accountants must address in reporting periodic income to external users?

Measuring issues: What amounts should be recognized? -Recognition issues: When should the effects of operation activities be recognized?

Net profit margin ratio

NI/Net sales (or operating rev) high NPM signals more efficient management of sales and expenses

14. Which of the following statements are true about rent paid in advance?

Prepaid Rent is an asset because cash has been paid in advance for future use. Rationale: Prepaid Rent is an asset on the balance sheet and represents the amount of rent paid in advance. Prepaid Rent will be expensed during the period the rent is used. The amount of rent used during the period is reported on the income statement as Rent Expense. Prepaid Rent is on the balance sheet and reports the amount paid in advance. Rationale: Prepaid Rent is an asset on the balance sheet and represents the amount of rent paid in advance. Prepaid Rent will be expensed during the period the rent is used. The amount of rent used during the period is reported on the income statement as Rent Expense.

20. Which of the following statements are true about supplies? (Check all that apply.)

Supplies is on the balance sheet and reports the amount of supplies on hand. Supplies are assets because they have not yet been used. Supplies Expense is on the income statement and reports the amount of supplies used during the period. # 21. In an effort to meet investors' expectations, managers may feel pressure to ______. # overstate revenues overstate net income record cash collected in advance as revenue

4. True or false: Income Tax Expense may also be called Provision for Income Taxes.

True

22. Which of the following statements are correct regarding Unearned Revenue?

Unearned Revenue is a liability account which is set up when a customer pays in advance for a product or service. Unearned Revenue refers to a liability that is settled when a company delivers a product or performs a service.

2. On May 30, Blade for Blade, Inc. collected $10,000 from customers in advance. In June, it earned $2,000 of the amounts collected in advance. In June, ______. (Select all that apply.)

Unearned Revenue is decreased Revenue is increased

7. On May 30, The Merchant of Tennis, Inc. collected $1,000 from customers in advance. In June, it earned $600 of the amounts collected in advance. What is the effect of these events on The Merchant of Tennis in May and June?

Unearned Revenue is decreased in June Revenue is increased in June Cash is increased in May Unearned Revenue is increased in May

19. In its first year of business, Wok 'n' Roll, Inc. earned $100,000 of revenues of which $80,000 was collected. It also incurred $90,000 in expenses for which $80,000 was paid. Which of the following statements are correct? (Check all that apply.)

Wok 'n' Roll should use accrual basis accounting for external reporting purposes to conform with GAAP and IFRS. Wok 'n' Roll should report net income of $10,000 for external reporting purposes.

25. Although the unadjusted trial balance's debits equal credits, some balances are not properly stated because ______ have not yet been recorded. (Check all that apply.)

adjusting entries some expenses incurred some revenues earned

17. If a real estate company fails to record the amount of commission revenue it has earned but not yet collected, then ______.

assets are understated and net income is understated

18. Income distributed to stockholders are ______ and ______ Retained Earnings

dividends; decrease

revenues

increases net income and SE. Credits go UP Accounts have credit balances

12. Unearned Revenue is a(n) ______ and is _____ when cash is collected in advance of being earned.

liability; credited

23. Retained Earnings represents ______.

nett income generated by the company through profitable operations that has not been distributed to its stockholders amounts earned (revenues minus expenses) that have been kept by the company

3. The gain from the sale of investments are ______ on the income statement.

not included as operating income but are included in net income

9. Accrual basis accounting differs from cash basis accounting in that accrual basis accounting records ______.

revenues in the period when the revenue is earned, even though the cash has not yet been collected expenses in the period incurred, even though cash has not yet been paid

10. On the income statement, Income from Operations differs from Income before Income Taxes in that ______ are subtracted from Income from Operations to arrive at Income before Income Taxes.

transactions that are non-operating or infrequently occurring

24. Retained earnings is increased with ______.

when revenues exceed expenses credits

6. When reporting net income to users, accountants must determine _____.

when the effects of operating activities and what amounts should be recorded