Financial Accounting Chapter 3

Which of the following statements are correct? (1) For accrual basis accounting, revenues are recorded when earned. (2) For accrual basis accounting, expenses are recorded when cash is paid. (3) For cash basis accounting, revenues are recorded when cash is received. (4) For cash basis accounting, expenses are recorded when benefit is received. (1) and (4) (2) and (3) (1) and (3) (2) and (4)

(1) and (3)

Of the following six accounts, which ones have temporary balances? (1) Service Revenue (2) Dividends (3) Salaries Expense (4) Common Stock (5) Retained Earnings (6) Cash (1), (3), and (5) (1), (2), and (3) (2), (4), and (5) (4), (5), and (6)

(1), (2), and (3)

Which relationship between revenue and expense recognition is implied in the matching principle?

Cause and Effect

Closing Entries, Expenses and Dividends

all expense and dividend accounts have debit balances. So, we credit each of these accounts for its balance and debit Retained Earnings for the total.

the revenue recognition principle

requires that revenue be recognize in the accounting period when it is earned

Depreciation Expense

the portion of a plant asset's cost that is transferred to an expense account in each fiscal period during a plant asset's useful life

current liabilities

those due during the next year

Long-Term Liabilities

those due in more than one year

Post-closing trial balance

A list of all accounts and their balances at a particular date after we have updated account balances for closing entries

Expense Recognition Principle

A principle, sometimes called the matching principle, that requires expenses to be recorded in the same period as the related revenue

indicate the accounts that will be debited and credited when the adjusting entries are made at the end of the month. On February 1, an insurance company receives a premium of $4,000 cash from another company in an agreement to provide insurance of $1,000 each month for the next four months, beginning in February. Think from the insurance company's perspective.

Debit- Unearned Revenue ,Credit Service Revenue (The adjusting entry for an unearned revenue always includes a debit to a liability account and a credit to a revenue account.)

indicate the accounts that will be debited and credited when the adjusting entries are made at the end of the month. At the end of May, a company receives a utility bill for $500 associated with operations in May. The company plans to pay the bill on June 10.

Debit- Utilities Expense, Credit-Utilities Payable ( The adjusting entry for an accrued expense always includes a debit to an expense account (increase an expense) and a credit to a liability account (increase a liability). )

indicate the accounts that will be debited and credited when the adjusting entries are made at the end of the month. On August 1, a bank lends $5,000 to a company at an annual interest of 12% on the borrowed amount. Think from the bank's perspective.

Debit-Interest Receivable, Credit- Interest Revenue [The adjusting entry for an accrued revenue always includes a debit to an asset account (increase an asset) and a credit to a revenue account (increase a revenue).]

In the adjusted trial balance, the balance of the Retained Earnings account is its balance at the end of the accounting period—the balance after all revenue, expense, and dividend transactions. True False

False, Think of why we would need a post-closing trial balance.

A publisher sends magazines on a monthly basis to a customer throughout 2013. The customer had paid for this subscription in December 2012. For the February edition of the magazine, the publisher purchases paper in January by issuing a notes payable. The note is paid in March 2013. When should the company report the costs associated with the purchase of paper? December 2012 January 2013 March 2013 February 2013

February 2013, We match expenses to the revenues they help to generate.

On April 1, a $4,800 premium on a one-year insurance policy was paid and debited to Prepaid Insurance. At the end of the year, the financial statements would report... Insurance Expense of $1,200, and Prepaid Insurance of $3,600. Insurance Expense of $3,600, and Prepaid Insurance of $1,200. Insurance Expense of $4,800, and Prepaid Insurance of $0. Insurance Expense of 3,650, and Prepaid Insurance of $4,800. .

Insurance Expense of $3,600, and Prepaid Insurance of $1,200.

Which of the following accounts is (are) listed in a post-closing trial balance? Prepaid Rent Accounts Payable Salaries Expense Two of these three accounts would be included in a post-closing trial balance. .

Prepaid Rent, Accounts Payable

Cash-basis accounting

Record revenues at the time cash is received and expenses at the time cash is paid

Accrual-basis accounting

Recording revenues when earned (the revenue recognition principle) and expenses with related revenues (the matching principle). -OR- Under this basis of accounting, revenues and expenses are reported in the income statement in the period in which they are earned or incurred.

Which of the following provides the balance of retained earnings to be used in a classified balance sheet? Statement of stockholders' equity Adjusted trial balance Income Statement Statement of Cash flows

Statement of stockholders' equity, For the classified balance sheet, we need the ending balance of retained earnings.

Which of the accounts are lsited in a Post-closing Trial balance? Select all that apply. Salaries Expense Supplies Retained Earnings Dividens Service Revenue Unearned Revenue

Supplies, Retained Earnings, Unearned Revenue (think of accounts that are closed out to retained earnings)

Posting an adjusting entry On January 4, a company purchases supplies worth $1,500. Suppose that at the end of January, a count of supplies reveals that only $1,000 of supplies remains. Supplies, an asset, has to be reduced by $500 and supplies expense has to be increased.

The adjusting entry involves a debit to Supplies Expense and a credit to Supplies. This adjusting entry is then posted to the company's General Ledger accounts. As shown, supplies are reduced by $500, and the ending balance is $1,000. This entry does not affect any liabilities. Stockholder's equity decreases by $500 as expenses increase.

Post adjusting entry Assume that a company pays total salaries to its employees of $150 per day. For the first four weeks (28 days), the company pays $4,200 cash to employees. For the remaining three days in January, employees earn additional salaries of $450, but the company doesn't plan to pay the employees until the end of the week, February 4. However, it must record the $450 salaries expense in January, the month in which the employees worked.

The adjusting entry involves a debit to an expense account, which in this case is Salaries Expense, and a credit to a liability account, which is Salaries Payable. The net effect is an increase in both expenses and liabilities. This adjusting entry is then posted to the company's General Ledger accounts. This entry does not affect assets. As shown, Salaries Payable are increased by $450, and the ending balance in this account is $450. Now let us look at stockholders' equity. Before adjustment, the Salaries Expense account had a debit balance of $4,200 to account for expenses incurred for the first 28 days. This adjustment increases salaries expense by $450. The balance in the Salaries Expense account is now $4,650.

Post Adjusting Entry A company provides $800 of recording services to customers from January 28 to January 31. However, it usually takes the company one week to mail bills to customers and another week for customers to pay. Therefore, it expects to receive cash from these customers during February 8-14. Because the company earned the revenue in January (regardless of when cash receipt takes place), it should recognize in January the service revenue and the amount receivable from the customers.

The adjusting entry would increase an asset—Accounts Receivable—by debiting $800 and will also increase Service Revenue by crediting it. Now, let's post this adjusting entry to the company's General Ledger accounts. Assume that before adjustments, the Accounts Receivable account had a balance of $2,900. The adjusting entry increases Accounts Receivable by $800. The balance including other receivables for January is now $3,700. This entry does not affect any liability. Now let's look at the Stockholders' Equity section. Before adjustments, this account had a balance of $7,200. Notice that we had credited $400 from an earlier transaction when the company performed $400 worth of recording services. Now we credit the Service Revenue T-account by $800. Notice that the new balance in the Service Revenue account is 8,400.

Adjusting Process

The analysis and updating of the accounts at the end of the period before the financial statements are prepared.

Operating cycle

The average time between purchasing or acquiring inventory and receiving cash proceeds from its sale

Revenue recognition principle

The concept that supports recording revenues when services have been performed or products delivered to customers.

Prepaid expenses

The costs of assets acquired in one period that will be expensed in a future period. -OR- Items such as supplies that will be used in the business in the future.

Book Value of the Asset (or net book value)

The difference between the cost of a fixed asset and its accumulated depreciation.

Revenue Recognition

The process of recognizing revenues.

Depreciation

The systematic periodic transfer of the cost of a fixed asset to an expense account during its expected useful life.

Adjusted Trial Balance

The trial balance prepared after all the adjusting entries have been posted. A list of all accounts and their balances after we have updated account balances for adjusting entries. Let us look at the relationship between an unadjusted trial balance (before adjustments) and an adjusted trial balance (after adjustments). Recall that in our first adjusting entry, we adjusted the Supplies account from $1,500 to $1,000 by reducing its balance by $500. The adjustment to supplies also resulted in Supplies Expense of $500 recorded. The other three adjustments are for revenue earned from previously unearned amounts, employee salaries owed but not paid, and revenue earned with no cash collection yet. These adjustments are included in the adjusted trial balance the same way. After any other adjustments are made—for example, assume that we also adjust for rent, depreciation, utilities, and interest—the adjusted trial balance is complete.

Salaries Payable are due....

These are due during the next year.

Notes Payable are typically due.....

These are typically due in more than one year.

Property and Equipment Provides a benefit for how long?

These provide a benefit for more than one operating cycle.

Prepaid insurance Provides a benefit for how long?

These provide a benefit over the next year.

Posting an adjusting entry On January 15, a company receives $2,000 in advance from customers who will record 5 audio lectures in the future. Assume that by the end of January, the company has recorded 1 audio lecture paid in advance. One-fifth of the work is now complete.

This requires an adjusting entry for the $400 that the company has already earned for providing the service. Let's look at the adjusting entry now. Unearned Revenue, a liability account, is debited by $400, and the Service Revenue account is credited for the same amount. This adjusting entry is then posted to the company's General Ledger accounts. This entry does not affect any assets. As shown, unearned revenues are reduced by $400, and the ending balance is $1,600. Stockholders' equity increases as revenues increase. Note that the company had other revenues of $7,200 during the month before this adjustment. The ending balance in the Service Revenue account is now $7,600.

Depreciate

To lose usefulness as all fixed assets except land do.

The balance of Retained Earnings account in the post-closing trial balance will be different from that of the adjusted trial balance. True False

True, Adjusted trial balance contains the beginning balance of retained earnings.

All accounts that appear in the balance sheet, including Retained Earnings, are permanent accounts, and we carry forward their balances from period to period. True False

True, Think of accounts that permanently appear in a balance sheet.

Cash Basis of Accounting

Under this basis of accounting, revenues and expenses are reported in the income statement in the period in which cash is received or paid.

On January 4, a company purchases supplies worth $1,500. Suppose that at the end of January, a count of supplies reveals that only $1,000 of supplies remains. This means that $500 worth of supplies were used during this period. How would you record this?

We make a single adjusting entry at the end of the month for the total amount used during the period. To record one month of the cost of supplies as an expense in January, we increase the expense account Supplies Expense by debiting it. Supplies, which are assets, are reduced by $500 with a credit entry. Notice that the adjusting entry includes a $500 expense. January 31 Debit Credit Supplies Expense 500 Supplies 500

Accrued expense

When a company has incurred an expense but hasn't yet paid cash or recorded an obligation to pay.In the case of accrued expenses, we paid cash after we incurred the expense and recorded a liability. The adjusting entry for an accrued expense always includes a debit to an expense account (increase an expense) and a credit to a liability account (increase a liability).

The Retained Earnings account had a beginning credit balance of $26,000. During the period, the business had a net loss $12,000, and the company paid dividends of $8,000. The ending balance in the Retained Earnings account is... $14,000 $30,000 $6,000 $22,000

6000

Matching Principle (Plant Assets)

A concept of accounting in which expenses are matched with the revenue generated during a period by those expenses. In a given period, we report revenue as it is earned, according to the revenue recognition principle. It's only logical, then, that in the same period we should also record all expenses incurred to generate that revenue. The result is a measure—net income—that matches current period revenues and expenses. That's the matching principle in a nutshell.

Accumulated Depreciation

A contra asset account representing the total depreciation taken to date.

Deferral

A deferral occurs when cash related to a future revenue or expense has been initially recorded as a liability or an asset.

Adjusted trial balance

A list of all accounts and their balances after we have updated account balances for adjusting entries

Permanent accounts

All accounts that appear in the balance sheet. Account balances are carried forward from period to period

Closing Entries, Revenues

All revenue accounts have credit balances. To transfer these balances to the Retained Earnings account, we debit each of these revenue accounts for its balance and credit Retained Earnings for the total.

Temporary accounts

All revenue, expense, and dividend accounts. Account balances are maintained for a single period and then closed (or zeroed out) and transferred to the balance of the Retained Earnings account at the end of the period

Contra account

An account with a balance that is opposite, or "contra," to that of its related accounts. -OR- An account offset against another account.

Vertical Analysis

An analysis that compares each item in a current statement with a total amount within the same statement.

Classified balance sheet

B/S that groups a company's assets into current assets and long-term assets and that separates liabilities into current liabilities and long-term liabilities

Which of the following is (are) true regarding the characteristics of adjusting entries? Adjusting entries reduce the balance of revenue, expense, and dividend accounts to zero. Adjusting entries allow for the proper application of the revenue recognition principle. Adjusting entries allow for the proper application of the matiching principle. Both b and c are true.

Both b and c are true.

indicate the accounts that will be debited and credited when the adjusting entries are made at the end of the month. On January 1, a company pays one year of rent in advance for $12,000 ($1,000 per month).

Debit- Rent Expense, Credit-Prepaid Rent [The adjusting entry for a prepaid expense always includes a debit to an expense account (increase an expense) and a credit to an asset account (decrease an asset).]

Closing entries

Entries that transfer the balances of all temporary accounts (revenues, expenses, and dividends) to the balance of the Retained Earnings account

Adjusting entries

Entries used to record events that occur during the period but that have not yet been recorded by the end of that period. -OR- The journal entries that bring the accounts up to date at the end of the accounting period.

The post-closing trial balance does not include any revenues, expenses, or dividends, because these accounts are permanent accounts. True False

False, The post-closing trial balance does not include any revenues, expenses, or dividends, because these accounts all have zero balances after closing entries.

A publisher sends magazines on a monthly basis to a customer in 2013. According to the revenue recognition principle, it should report this revenue in its 2012 income statement, if it received cash for the magazine subscription in 2012. True False

False, Think about when the company earns this revenue.

Which financial statement reports revenue and expense accounts?

Income Statement

Fixed Assets (or plant assets)

Long-term or relatively permanent tangible assets such as equipment, machinery, and buildings that are used in the normal business operations and that depreciate over time.

indicate the accounts that will be debited and credited when the adjusting entries are made at the end of the month. A company provides tutoring services to customers during two weeks in April. Customers pay cash in April.

No entry required (This transaction involves the recognition of revenues and therefore will not require month-end adjusting entries. )

Matching principle

Recognize expenses in the same period as the revenues they help generate

The balance of which permanent account is affected by closing entries?

Retained Earnings (Think of the account to which we transfer the balance of all revenue, expense, and dividend accounts.)

Closing Entries, Retained Earnings

Retained Earnings is credited or increased in the first entry and then debited or decreased in the second and third entries.

The closing entry for which of the following accounts will result in an increase in retained earnings?

Revenues, Think of a closing entry in which retained earnings is credited.

Which of the following is a temporary account? Retained Earnings Salaries Expense Accounts Receivable Cash

Salaries Expense (Revenues, expenses, and dividends are termed temporary accounts.)

Which of the following is an example of a current asset? Equipment Common stock Accounts Payable Supplies

Supplies, Some examples of current assets are cash, accounts receivable, supplies, and prepaid rent.

Unearned revenues

When a company receives cash in advance from a customer for products or services to be provided in the future. Example-When customers pay cash in advance, we debit cash and credit a liability. This liability reflects the company's obligation to provide goods or services to the customer in the future. After the company has provided these products or services, the company can record revenue earned and reduce its obligation to the customer. The adjusting entry for an unearned revenue always includes a debit to a liability account and a credit to a revenue account. -OR- The liability created by receiving revenue in advance.

Once we have prepared the closing entries, the balance of each revenue, expense, and dividend account equals...

Zero

The adjusting entry required when amounts previously recorded as unearned revenues are earned includes... a credit to an asset a credit to a liability a debit to a liability a debit to an asset

a debit to a liability

post-closing trial balance

a list of all accounts and their balances at a particular date after we have updated account balances for closing entries. The post-closing trial balance helps to verify that we prepared and posted closing entries correctly and that the accounts are now ready for the next period's transactions. Notice that the post-closing trial balance does not include any revenues, expenses, or dividends, because these accounts all have zero balances after closing entries. The balance of Retained Earnings has been updated from the adjusted trial balance to include all revenues, expenses, and dividends for the period.

Adjusting entries... always involve at least one income statement account and one balance sheet account. usually are recorded at the beginning of the accounting period. adjust the balance of revenue and expense accounts to zero. often include the account, Cash.

always involve at least one income statement account and one balance sheet account.

During a discount sale, Larry buys a CD from Best Buy. Rather than paying cash, Larry uses his Best Buy card to buy the CD on account. When will Best Buy record revenue from this sale?

at the time of sale, The revenue recognition principle states that we should recognize revenue in the period in which we earn it, not necessarily in the period in which we receive cash.

Which of the following is an objective for preparing closing entries? a. To record the exact balances of all accounts and prepare them for measuring activity in the next period. b. To make sure that proper adjustments are made before preparing an adjusted trial balance. c. To reverse the effects of double-entry bookkeeping and ensure that the accounting equation is in balance. d. To transfer the balances of temporary accounts to the Retained Earnings account.

d. To transfer the balances of temporary accounts to the Retained Earnings account. (Note that closing entries "close out" certain accounts.)

An adjusted trial balance... is a list of all accounts and their balances after closing entries. is a trial balance adjusted for cash-basis accounting. is a list of all accounts and their balances before adjusting entries. is a list of all accounts and their balances after adjusting entries.

is a list of all accounts and their balances after adjusting entries.

Accruals

occur when the cash flow occurs after either the expense is incurred or the revenue is earned. Accruals are the opposite of prepayments. -OR- An accrual occurs when revenue has been earned or an expense has been incurred but has not been recorded

The _____ is the average time between purchasing inventory and receiving cash proceeds from its sale.

operating cycle

The primary purpose of closing entries is to... assure that adjusting entries balance. prove the equality of the debit and credit entries in the general journal. update the balance of Retained Earnings and prepare revenue, expense, and dividend accounts for the next period's transactions. ensure that all assets and liabilities are recognized in the appropriate period.

update the balance of Retained Earnings and prepare revenue, expense, and dividend accounts for the next period's transactions.

accrued revenue

when a company has earned revenue but hasn't yet received cash or recorded an amount receivable In the case of accrued revenues, we receive cash after we earned the revenue and recorded an asset. The adjusting entry for an accrued revenue always includes a debit to an asset account (increase an asset) and a credit to a revenue account (increase a revenue).