Accounting Chapter 4

Which account is credited to recognize the income tax consequences of operating at a loss?

Income tax expense

True or False: A bill or other source document indicate the need to prepare an adjusting entry.

False

True or false: Materiality is determined by a strict formula

False

An adjusting entry to accrue an unpaid expense had which effect?

Increase Liabilities

Every adjusting entry involves recognition of revenue or expense

Revenue and expense represent changes in owner's equity

Niemeir issued a 1 year interest bearing note on April 1, Year 1. The face amount of the note is $500,000 and the interest rate is 3%. Interest is payable semi-annually ( i.e. on October 1 and April 1). Niemier prepares adjusting entries quarterly and operates on a calendar year basis. Cash interest paid during year 1 is

$11,250

Mercy Hospital's weekly payroll of $14,000 is paid every Friday. Mercy operates on a calendar-year basis, and the last Friday in December, Year 1, is December 25. The entry on January 1, Year 2, to pay salaries expense of $2,000.

$14,000-$12,000 (expense of Year 1) =$2,000

Puckett, Inc. sells 2 year magazine subscription for $4800 on June 1, year 1. Puckett's fiscal year ends December 31. Adjusting entries are prepared quarterly. At December 31, Year 2, the Revenue account is credited for

$600

Niemeir issued a 1 year interest bearing note on April 1, Year 1. The face amount of the note is $500,000 and the interest rate is 3%. Interest is payable semi-annually ( i.e. on October 1 and April 1). Niemier prepares adjusting entries quarterly and operates on a calendar year basis. Cash interest paid during year 1 is

$7,500

Accounting Analytics provides litigation support services, primarily to law firms and government agencies. Accounting analytics bills clients on the first day of each quarter. Based Accounting Analytics calendar year basis. Accounting Analytics prepares adjusting entries monthly. During October, Accounting Analytics entered into a consulting arrangement with law firm Connolly and Williams. Billable hours devoted to this engagement were as follows: October 100, November 250, December 400. Accounting Analytics average billable hour is $350. At November 30, Accounting Analytics will debit Accounts Receivable for

$87,000 $350 * 250 = $87,500

How does converting assets to expenses affect the elements of a financial statement

- It decreases owner's equity - It decreases net income - It decreases assets -It increases expenses

Revenue earned in the current period that will be collected in a future period represents the

Accrual of Revenue

Contra-asset account

An account with a credit balance that is offset against or deducted from an asset account to produce the proper balance sheet amount for the asset.

Every adjusting entry affects

Either a revenue account or an expense account

Recording advance collections direction in the revenue accounts

We stressed that amounts collected from customers in advance represents liabilities, not revenue. However, some companies follow an accounting policy of crediting these advance collections directly to revenue accounts. The adjusting entry then should consist of a debit to the revenue account and a credit to the unearned revenue account for the portion of the advance payment not yet earned.

Adjusting Entries

are needed at the end of each accounting period to make certain that appropriate amounts of revenue and expense are reported in the company's income statement.

Adjusting entries

are needed at the end of each accounting period to make certain that appropriate amounts of revenue and expense are reported in the company's income statement.

The expiration of a portion of a depreciable asset's usefulness is recorded as

depreciation expense

Book value

is not intended to represent current market value.

Depreciation expense =

Cost of the asset / Estimated useful life

Matching Principle

The generally accepted accounting principle that determines when expenses should be recorded in the accounting records. The Revenue earned during an accounting period is matched (offset) with expenses incurred in generating that revenue

Book Value

The net amount at which an asset appears in financial statements. Fore Depreciable assets, blook vlaue represents cost minus accumulated depreciation. Also called carrying value.

Materiality concept

The relative importance of an item or amount. Items significant enough to influence decisions are said to be immaterial. Items lacking this importance are considered immaterial. The accounting treatment accorded to immaterial items may be guided by convenience rather than theoretical principles

Straight line method of depreciation

The widely used approach of recognizing an equal amount of depreciation expense in each period of a deprecable asset's useful life.

Prepaid Expenses

Assets representing advance payment of the expenses of future accounting period. As time passes, adjusting entries are made to transfer the related costs from the asset account to the expense account

Adjusting entries are based on accrual accounting, not monthly bills or year end transactions.

Making adjusting entries requires a greater understanding of accrual accounting than does the recording of routine business transactions.

Which effect does a failure to accrue uncollected Revenue have on the elements of a financial statement?

Owner's equity is understated

Accumulated Depreciation is classified as an

contra-asset account

Adjusting entries that represent Deferrals are needed to

1. Convert an asset to an expense 2. Convert a liability to a revenue

Which of the following are examples of expenditures that are changed to expense based on systematic allocation over time

1. Depreciation 2. Insurance

An adjusting entry has the effect of moving a portion of recorded liability amount from the balance sheet to the income statement has the effect of

1. Increasing revenues 2. Decreasing Liabilities

Which type of business has little if any unearned revenue

restaurants

Seymour, Inc. purchased $3,200 worth of supplies on November 15, debiting Supplies Expense for that amount and crediting cash. At December 31, $850 of supplies are left on hand. Seymour prepares adjusting entries on December 31. The balance in Supplies Expense at December 31 after the adjusting entry has been made will be

$2350

Noble bought $12,000 of supplies on March 15. At March 31, $8,400 of supplies are on hand. Assuming adjusting entries are prepared monthly, Supplies Expense will be debited for

$3,600

Bricker, Inc. accrues income tax expense at 40% of pretax income. Estimated taxes are paid on the 15th of April, June, September, December. Brick operates on a calender-year basis and prepares adjusting entries annually. Bricker's pretax income for the year is $900,000. Estimated tax payments of $75,000 have been paid on each of the above 4 dates. Income tax expense for the year is

$360,000 $900,000 *.4 = $360,000

Harris News Receives payments on 3 months newspaper subscription of $9,000 on December 1. On December 1, Harris debits cash $9,000 and credits revenue $9,000, Adjusting entries are prepared monthly. During this first year, Harris will recognize $3,000 of revenue

$9,000- ($9,000 * 2/3) $3,000 = $3,000

Kroeker, Inc. purchased an automobile for $60,000 on August 1 of Year 1. The useful life of the automobile is 5 years. Adjusting entries are prepared monthly. Depreciation expense for the first 9 month of year 2 is

$9,000= (($60,000/12 month)=$1,000)*9 month of depreciation

Adjusting entries that represent deferrals are needed to

1. Convert an asset to an expense 2. Convert a liability to revenue

4 types of adjusting entries

1. Converting assets to expense 2. Converting liabilities to revenue 3. Accruing unpaid expense 4. Accruing uncollected revenue

The adjusting entry to record the expiration of 1 month of insurance

1. Crediting Unexpired Insurance (Asset) and 2. Debiting Insurance Expense (Expense Account) (decrease in owner's equity)

The adjusting entry to record salaries earned in this accounting period but not to be paid until the next accounting period involves

1. Debiting Salary Expense 2. Crediting salaries payable

The adjusting entry for recognize 1 month of revenue for a 2 year magazine subscription paid in advance involves:

1. Debiting Unearned Revenue AND 2. Crediting Revenue When the money was received for the subscription: the cash (asset) account was debited. The Unearned Revenue (liability account ) was credited.

An adjusting entry to move a portion of as asset cost from the balance sheet to the income statement has the effect of

1. Decreasing assets 2. Increasing Expenses

In order to implement the matching principle, costs are matched against revenue in which of the following ways

1. Direct association of costs with revenue 2. Systematic allocation of costs over time.

Every adjusting entry affects

1. Either an asset or liability account and 2. Either a revenue account or an expense account Every adjusting entry involves recognition of either revenue or expenses. Revenue and Expense represent changes in owner's equity. Owner's equity cannot change by itself; there also must be a corresponding change in either assets or liabilities. Every adjusting entry affect both an income statement account (revenue or expense) and a balance sheet account ( asset or liability)

An adjusting entry to move a portion of an asset's cost from the balance sheet to the income statement has the effect of

1. Increasing Expenses 2. Decreasing Assets

How does converting liabilities to revenue affect the elements of a financial statement?

1. It decreases liabilities 2. It increases revenue 3. It increase net income 4. It increase owner's equity

Building is an example of a contra-asset account because

1. It has a credit balance 2. It is offset against an asset account (Building) to produce the book value for the asset. 3.

How does converting liabilities to revenue affect the elements of the financial statement

1. It increases owner's equity. 2. It increases revenue 3. Increases net income 4. It decreases liabilities

Adjusting entries that represet accruals are needed

1. Recognized revenue earned before cash is received. 2. Recognize expenses incurred before cash is disbursed.

Which of the following factors are considered when evaluating whether or not an item is material.

1. Size of the organization 2. Dollar amount of the item 3. Nature of the item.

Converting liabilities to revenue

A business may collect cash in advance for services to be rendered in future accounting periods. Transactions of this nature are usually recorded by rendered in future accounting periods. Transactions of this nature are usually recorded by debit cash and crediting a liability account (typically called unearned revenue or Customer deposits). Here, the liability account created represents the deferral (or the postponed) of revenue. In the period that services are actually rendered (or that goods are are sold), an adjusting entry is recorded by debiting the liability (Unearned Revenue or Customer deposits) and by crediting Revenue Earned (or a similar account) for the value of the services.

Adjusting entry 1: Converting assets to expense

A cash expenditure (or cost) that will benefit more than one accounting period usually is recorded by debiting an asset account ( for example, supplies, unexpired insurance, ...etc.) and by crediting cash. The asset account created actually represents the deferral (or the postponement) of an expense. In each future period that benefits from the use of this asset, an adjusting entry is made to allocate a portion of the asset's cost from the balance sheet to the income statement as an expense. This adjusting entry is recorded by debiting the appropriate expense account. (for example, supplies expense or insurance expense) and crediting the related asset account ( for example, supplies or unexpired insurance.)

Accruing unpaid expenses

An expense may be incurred in the current accounting period even though no cash payment will occur until a future period. These accrued expenses are recorded by an adjusting entry made and the end of each accounting period. The adjusting entry is recorded by debiting the appropriate expense account (for example, interest expense or salary expense) and by crdieting the related liability ( for example interest payable or salaries payable)

Unearned Revenue

An obligation to deliver goods or render services in the future, stemming from the receipt of advance payment. The balance of an unearned revue accout is considered to be a liability . It appears in the liability section of the balance sheet, not in the income statement.

When a business makes an expenditure that will benefit more than one accounting period, the amount usually is debited to an asset account.

At the end of each period benefitting from this expenditure, an adjusting entry is made to transfer an appropriate portion of the cost from the asset account to the expense account

Matching principle underlies such accounting practices as depreciating plant assets, measuring the cost of supplies used and amortizing the cost of unexpired insurance policies. Costs are matched with revenue in one of two ways

Costs are matched with revenue in one of two ways: 1. Direct association of costs with specific revenue transactions 2. Systematic allocation of costs over the useful life of the expenditure

A cash expenditure that benefits more than 1 period represent

Deferral of an expense

The largest cause of the difference between net income and cash flow from operations is typically

Depreciation Expense

The largest cause of the defference between net income and cash flow from operations is typically

Depreciation expense.

An adjusting entry to accrue revenue has which effect(s)?

Increases assets

Accruing uncollected revenue

Revenue may earned (or accrued) during the current period, even though the collection of cash will not occur until a future period. Unrecorded earned revenue, for which no cash has been received, requires an adjusting entry at the end of the accounting period. The adjusting entry is recorded by debiting the appropriate asset. (For example, Accounts Receivable or Interest Receivable) and by crediting the appropriate revenue account (for example, Service Revenue Earned or Interest Earned)

Accouting Analytics provides litigation support services primarily to law firms and government agencies. Accounting Analytics bills clients on the first day of each quarter, based on Accounting Analytics' calender-year basis. Accounting Analytics prepares adjusting entries monthly. During October, Accounting Analytics entered into a consulting arrangement with the law firm of Connolly & Williams. Billable hours devoted to this engagement during the last quarter were as follows: October 100, November 250, December 400. Accounting Analytics average billable hour is $350. At November 30, Accounting Analytics will debit Accounts Receivable _____________

Should be $87,500 (based on 250 hours in November times $350 an hour)

Materiality and Adjusting Entries

The concept of materiality enables accountants to simplify the process of making adjusting entries in several ways: 1.Businesses purchase many assets that have very low costs or will be consumed quickly in business operations. Examples: waterbaskets, lightbulbs, etc.. The materiality concept permit charging such purchased directly to expense accounts, rather than to asset accounts. This treatment conveniently eliminates the need to prepare adjusting entries to depreciate these items. 2. Some expenses, such as telephone bills and utility bills may be charged to expense as the bills are paid, rather than as the services are used. Technically this is the matching principle. However, accounting for utility bills on a cash basis is very convenient as the monthly cost of utlility service is not known untile the bill is received. The amount of utility expense recorded each month is actualy base on the prior months bill. 3. Adjusting entries to accrue unrecorded expense or unrecorded revenue may actually be ignored if the dollar amounts are immaterial.

Owner's equity can not change by itself

There must be a corresponding change in either assets or liabilities

Realization (principle)

This accounting principle that governs the timing of revenue recognition. Basically, the principle indicates that revenue should be recognized in the period in which it was earned.

An adjusting entry to a convert an asset to an expense account

This adjusting entry reflects the fact that the part of the asset has been used up or become an expense during the current accounting period.

Depreciation is a non cash expense

We have made the point that net income does not represent an inflow of cash or any other asset. Rather, it is a computation of the overall effect of certain business transactions on owner's equity. The recognition of depreciation expense illustrated this point. As depreciable assets exprie, depreciation expense is recorded, net income is reduced and owner's equity declines, but there is no corresponding cash outlay in the current period. For this reason, depreciation is called a non-cash expense. Often, it represents the largest difference between net income and the cash flow from business operations.

Timing differences between cash flows and the recognition of revenue and expenses are referred to as

accruals and deferrals

Depreciable assets

are physical objects that retain their size and shape that eventually wear out or become obsolete. They are not physically consume but nonetheless their economic usefulness diminishes over time. Examples of depreciable assets include buildings and all types of equipment, fixtures, furnishings and even railroad tracks.

Adjusting entries that represent deferrals are needed to

convert an asset to an expense convert a liability to revenue

Under the straight-line method of depreciation, depreciation expense is computed by dividing the asset's ___________________ by its _____________________________.

cost by its estimated useful life. depreciation expense = cost of the asset/ estimated useful life.

Most companies prepare adjusting entries on a

monthly basis