Chapter 2

What is the purpose of a worksheet? What would be the result of incorrectly transferring the balance in a liability account to column I, the credit column under Income Statement?

A worksheet provides a way to organize the accounting information needed to prepare adjusting and closing entries and the financial statements. This error would result in an overstatment of revenues and thus net income and thus retained earnings, and an understatement of liabilities.

Each economic event or transaction will have a dual effect on financial position. Explain what is meant by this dual effect.

According to the accounting equation, there is equality between the total economic resources of an entity, its assets, and the claims to those resources, liabilities, and equity. This implies that, since resources must always equal claims, the net effect of any transaction cannot affect one side of the accounting equation differently than other side.

Define accrued liabilities. When adjusting journal entry is required to record accrued liabilities?

Accrued liabilities are recorded when an expense has been incurred that will not be paid until a subsequent reporting period. The adjusting entry needed to record an accrued liability is a debit to an expense and a credit to a liability.

Describe what is meant by posting, the fourth step in the processing cycle.

After transactions are recorded in a journal, the debits and credits must be transferred to the appropriate general ledger accounts. This tranfer is called posting.

What is an unadjusted trial balance? An adjusted trial balance?

An unadjusted trial balance is a list of the general ledger accounts and thier balances at a time before any end-of-period adjusting enteries have been recorded. An adjusted trial balance is prepared after adjusting entries have been recorded and posted to the accounts.

Describe how debits and credits affect assets, liabilities, and permanent owners' equity accounts.

Assets are increased by debits and decreased by credits. Liabilities and equity accounts are increased by credits and decreased by debits.

Define closing entries and their purpose.

Closing entries transfer the balances in the temporary owners' equity accounts (revenues, expenses, gains, losses, dividends) to a permanent owners' equity account, retained earnings for a corporation. This occurs only at the end of a reporting period in order to reduce the temporary accounts to zero before beginning the next reporting year.

Explain the difference between external events and internal events. Give an example of each type of event.

External events involve an exchange transaction between the company and a separate economic entity. For every external transaction, the company is receiving something in exchange for something else. Internal events do not involve an exchange transaction but do affect the financial position of the company. Examples of external events are the purchase of inventory, a sale to a customer, and the borrowing of cash from a bank. Examples of internal events include the recording of decpreciation expense, the expiration of prepaid rent, and the accrual of salary expense.

Describe the events that correspond to the following two journal enteries: Inventory debit (20,000)/Accounts payable credit (20,000) Accounts receivable debit (30,000)/Sales revenue credit (20,000) Cost of goods sold debit (18,000)/Inventory (18,000)

In Transaction 1 we record the purchase of $20,000 of inventory on account. In Transaction 2 we record a credit sale of $30,000 and the corresponding cost of good sold of $18,000.

Explain the difference between permanent accounts and temporary accounts. Why does an accounting system include both types of accounts?

Permanent accounts represent the financial position of a company-assets, liabilities and owners' equity-at a particular point in time. Temporary accounts represent the changes in shareholders' equity, the retained earnings component of equity for a corporation, caused by revenue, expense, gain, loss, and dividend transactions. It would be cumbersome and less informative to record revenue/expense, gain/loss, and dividend transactions directly into the permanent retained earnings account. Recording these transactions in temporary accounts facilitates the preparation of the financial statements.

Define prepaid expenses and provide at least two examples.

Prepaid expenses represent assets recorded when a cash disbursement creates benefits that extend beyond the current reporting period. Examples are supplies on hand at the end of a period, prepaid rent, and prepaid insurance.

Describe how debits and credits affect temporary owners' equity accounts.

Revenues and gains are increased with credits and decreased with debits. Expenses, losses, and dividends are increased with debits (thus causing owners' equity to decrease) and decreased with credits (thus causing owners' equity to increase).

Define reversing entries and discuss their purpose.

Reversing entries are recorded at the beginning of a reporting period. They reverse the effects of some of the adjusting entries recorded at the end of the previous reporting period. This simplifies the journal entries recorded during the new period by allowing cash payments or cash receipts to be entered directly into the expense or revenue account without regard to the accrual recorded at the end of the previous period.

Deferred revenues represent liabilities recorded when cash is received from customers in advance of providing a good or service. What adjusting journal entry is required at the end of a period to recognize the amount of deferred revenues that were recognized during the period?

The adjusting entry required when deferred revenues are recgnized is a debit to the deferred revenue liability and a credit to revenue.

What is the first step in the accounting processing cycle? What role do source documents fulfill in this step?

The first step in the accounting processing cycle is to identify external transactions affecting the accounting equation. Source documents, such as sales invoices, bills from suppliers, and cash register tapes, help to identify the transactions and then provide the information necessary to process the transaction.

Explain the difference between the general ledger and a subsidiary ledger.

The general ledger is a collection of control accounts representing assets, liabilities, and permanent and temporary shareholders' equity accounts. The subsidiary ledger contains a group of subsidiary accounts associated with a particular general ledger control accounts. For example, there will be a subsidiary ledger for accounts receivable that will keep track of the increases and decreases in the account receivable balance for each of the company's customers purchasing goods and services on credit. At any point in time, the balance in the account receivable control account should equal the sum of the balances in the accounts receivable subsidiary ledger accounts.

What is the purpose of a journal? What is the purpose of a general ledger?

The purpose of a journal is to capture, in chronological order, the dual effect of a transaction in storage areas called accounts. A general ledger is an organized collection of accounts. The purpose is to keep track of the increases, decreases, and balances in each account.

What is the purpose of special journals? In what ways do they simplify the recording process?

The purpose of special journals is to record, in chronological order, the dual effect of repetitive types of transactions, such as cash receipts, cash disbursements, credit sales, and credit purchases. Special journals simplify the recording process in the following ways: -journalizing the effects of a particular transaction is made more efficient through the use of specifically designed formats -individual transactions are not posted to the general ledger accounts, but are accumulated in the special journals and a summary posting is made on a periodic basis - the responsibility for recording journal entries for the repetitive types of transactions is placed on individuals who have specialized training in handling them

Balance sheet

The purpose of the balance sheet is to present the financial position of a company at a particular point in time. It is an organized list of assets, liabilities, and permanant shareholders' equity accounts.

Income statement

The purpose of the income statement is to summarize the profit-generating activities of a company during a particular period of time. It is a "change statement" that reports the changes in shareholders' (owners') equity that occurred during the period as a result of revenues, expenses, gains, and losses.

Statment of cash flows

The purpose of the statement of cash flows is to disclose the events that caused cash to change during the period.

Statment of shareholders' equity

The purpose of the statement of shareholders' equity is to disclose the sources of the changes in the various shareholders' equity accounts that occurred during the period. This statment includes changes resulting from investments by owners, distribution to owners, net income, and other comprehensive income.

Statement of comprehensive income

The statement of comprehensive income extends the income statement to report changes in shareholders' equity during the reporting period that were not a result of transactions with owners. This statement includes net income and also other comprehensive income items.

Describe what is meant by transaction analysis.

Transaction analysis is the process of reviewing the source documents to determine the dual effect on the accounting equation and the specific element involved.

Define adjusting entries and discuss thier purpose.

We use adjusting entries to record the effect on financial position of internal events, those that do not involve an exchange transaction with another entity. We record them at the end of any period when financial statements are prepared to properly reflect financial position and results of operations according to the accrual accounting model, that is, to update accounts to thier proper balances before we report those balances in the financial statements.

worksheet

a means of organizing information; not part of the formal accounting system

Indicate which accounts should be debited and which accounts should be credited when preparing journal entries: Sold goods to customers on account.

debit - accounts receivable credit - sales revenue debit - cost of goods sold credit - inventory

Indicate which accounts should be debited and which accounts should be credited when preparing journal entries: Collected cash from customer for good sold on account.

debit - cash credit - accounts receivable

Indicate which accounts should be debited and which accounts should be credited when preparing journal entries: Issued common stock in exchange for cash.

debit - cash credit - common stock

Indicate which accounts should be debited and which accounts should be credited when preparing journal entries: Received cash for advance payment from customer.

debit - cash credit - deferred sales revenue

Indicate which accounts should be debited and which accounts should be credited when preparing journal entries: Borrowed cash from a bank and signed a note.

debit - cash credit - notes payable

Indicate which accounts should be debited and which accounts should be credited when preparing journal entries: Paid a cash dividend.

debit - dividends credit - cash

Indicate which accounts should be debited and which accounts should be credited when preparing journal entries: Purchased inventory on account.

debit - inventory credit - accounts payable

Indicate which accounts should be debited and which accounts should be credited when preparing journal entries: Paid rent for the next three months.

debit - prepaid rent credit - cash

Indicate which accounts should be debited and which accounts should be credited when preparing journal entries: Purchased supplies for cash.

debit - supplies cash - cash

Indicate which accounts should be debited and which accounts should be credited when preparing journal entries: At the end of October, recorded the amount of supplies that had been used during the month.

debit - supplies expense credit - supplies

Indicate whether a DEBIT will increase or decrease each of the following accounts listed: Accounts payable

decrease

Indicate whether a DEBIT will increase or decrease each of the following accounts listed: Common stock

decrease

Indicate whether a DEBIT will increase or decrease each of the following accounts listed: Interest revenue

decrease

Indicate whether a DEBIT will increase or decrease each of the following accounts listed: Salaries payable

decrease

Indicate whether a DEBIT will increase or decrease each of the following accounts listed: Sales revenue

decrease

Indicate whether a DEBIT will increase or decrease each of the following accounts listed: Utilities payable

decrease

transaction analysis

determine the dual effect on the accounting equation

Indicate whether a DEBIT will increase or decrease each of the following accounts listed: Accounts receivable

increase

Indicate whether a DEBIT will increase or decrease each of the following accounts listed: Cost of goods sold

increase

Indicate whether a DEBIT will increase or decrease each of the following accounts listed: Depreciation expense

increase

Indicate whether a DEBIT will increase or decrease each of the following accounts listed: Equipment

increase

Indicate whether a DEBIT will increase or decrease each of the following accounts listed: Interest expense

increase

Indicate whether a DEBIT will increase or decrease each of the following accounts listed: Inventory

increase

Indicate whether a DEBIT will increase or decrease each of the following accounts listed: Prepaid rent

increase

Indicate whether a DEBIT will increase or decrease each of the following accounts listed: Rent expense

increase

Indicate whether a DEBIT will increase or decrease each of the following accounts listed: Utilities expense

increase

adjusting entries

internal events recorded at the end of a reporting period

adjusted trial balance

list of accounts and thier balances after recording adjusting entries

post-closing trial balance

list of accounts and thier balances after recording closing entries

unadjusted trial balance

list of accounts and thier balances before recording adjusting entries

financial statements

primary means of disseminating information to external decision makers

journal

record of the dual effect of a transaction in debit/credit form

closing entries

to zero out the temporary accounts

posting

transferring balances from the journal to the ledger

source documents

used to identify and process external transactions