CH 3

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.

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 periods such as months, quarters, or years.

unclassified balance sheet

Balance sheet that broadly groups assets, liabilities, and equity accounts.

Accrued Expenses

Costs incurred in a period that are both unpaid and unrecorded; adjusting entries for recording accrued expenses involve increasing expenses and increasing liabilities.

High Step Shoes had annual revenues of $188,000, expenses of $105,200, and dividends of $19,200 during the current year. The retained earnings account before closing had a balance of $300,000. The entry to close the Income Summary account at the end of the year, after revenue and expense accounts have been closed, is:

Debit Income Summary $82,800; credit Retained earnings $82,800

The correct adjusting entry for accrued and unpaid employee salaries of $9,200 on December 31 is:

Debit Salary Expense, $9,200; credit Salaries Payable, $9,200.

Karl Company accrued wages of $7,950 that were earned by employees unpaid at the year-end. Assuming Karl uses reversing entries, which of the following entries correctly reverses the accrued wages at the beginning of the following year?

Debit Wages Payable $7,950; credit Wages Expense $7,950.

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 account (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.

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 account.

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 not used in operating activities such as notes receivable and investments in stocks and bonds.

straight line depreciation

Method that allocates an equal portion of the depreciable cost of plant asset (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.

long-term liabilities

Obligations not due to be paid within one year or the operating cycle, whichever is longer.

Current Liabilities

Obligations that a company expects to pay within the next year or 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.

A company earned $7,220 in net income for October. Its net sales for October were $19,000. Its profit margin is:

Profit Margin = Net Income/Net SalesProfit Margin = $7,220/$19,000 = 0.38 = 38%

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).

Cash Basis Accounting

Reporting income when the cash is received and expenses when the cash is paid.

High Step Shoes had annual revenues of $194,000, expenses of $108,200, and paid dividends of $21,600 during the current year. The retained earnings account before closing had a balance of $306,000. The Net Income for the year is:

Revenues $194,000 − Expenses $108,200 = Net Income $85,800

natural business year

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

The Unadjusted Trial Balance columns of a company's work sheet shows the Store Supplies account with a balance of $580. The Adjustments columns shows a credit of $325 for supplies used during the period. The amount shown as Store Supplies in the Balance Sheet columns of the work sheet is:

Unadjusted Store Supplies − Supplies used = Supplies unused $580 − $325 = $255

Every adjusting entry will include

a debit to an expense account and a credit to a revenue account

adjusted trial balance

a list of accounts and their balances after all adjustments have been made

Every adjusting entry affects

an income statement account and a balance sheet account

current assets

cash and other assets expected to be exchanged for cash or consumed within a year

pre-paid expenses

items paid for in advance of receiving their benefits classified as assets

profit margin

net income/net sales

On May 1, a two-year insurance policy was purchased for $12,000 with coverage to begin immediately. What is the amount of insurance expense that would appear on the company's income statement for the first year ended December 31?

$4000

Classified Balance Sheet

A balance sheet that groups together similar assets and similar liabilities, using a number of standard classifications and sections.

On July 1 of the current calendar year, Olive Co. paid $8,100 cash for management services to be performed over a two-year period beginning July 1. Olive follows a policy of recording all prepaid expenses to asset accounts at the time of cash payment. The adjusting entry on December 31 of the current year for Olive would include:

A debit to an expense and a credit to a prepaid expense for $2,025.

fiscal year

A fiscal period consisting of 12 consecutive months.

Contra Account

Account linked with another account and having an opposite normal balance; reported as a subtraction from the other account's balance.

Accrual Basis Accounting

Accounting basis in which companies record, in the periods in which the events occur, transactions that change a company's financial statements, even if cash was not exchanged.

Accumulated Depreciation

the cumulative sum of all depreciation expense from the date of acquiring a plant asset

Accounting Period

the time period covered by the financial statements

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 balances 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).

Unearned Revenue

The liability created by receiving revenue in advance.

Expense Recognition Principle

The principle that matches expenses with revenues in the period when the company makes efforts to generate those revenues.

If a company has current assets of $21,660 and current liabilities of $11,400. Its current ratio is 1.9.

True Current Ratio = Current Assets/Current LiabilitiesCurrent Ratio = $21,660/$11,400 = 1.9