Finance & managerial Accounting chp 3 notes
Unlock all answers in this set
Unlock answersquestion
Adjusting Accounts
answer
• Prepaid expenses • Unearned revenues • Accrued expenses • Accrued revenues • Adjusted trial balance
question
time period assumption
answer
presumes that an organization's activities can be divided into specific time periods such as a month, a three-month quarter, a six-month interval, or a yea
question
Explain the importance of periodic reporting and the time period assumption.
answer
The value of information is often linked to its timeliness. To provide timely information, accounting systems prepare periodic reports at regular intervals. The time period assumption presumes that an organization's activities can be divided into specific time periods for periodic reporting.
question
Explain accrual accounting and how it improves financial statements.
answer
Accrual accounting recognizes revenue when earned and expenses when incurred—not necessarily when cash inflows and outflows occur. This information is valuable in assessing a company's financial position and performance.
question
Identify steps in the accounting cycle.
answer
The accounting cycle consists of 10 steps: (1) analyze transactions, (2) journalize, (3) post, (4) prepare an unadjusted trial balance, (5) adjust accounts, (6) prepare an adjusted trial balance, (7) prepare statements, (8) close, (9) prepare a post-closing trial balance, and (10) prepare (optional) reversing entries.
question
Explain and prepare a classified balance sheet.
answer
Classified balance sheets report assets and liabilities in two categories: current and noncurrent. Noncurrent assets often include long-term investments, plant assets, and intangible assets. A corporation separates equity into common stock and retained earnings.
question
Explain how accounting adjustments link to financial statements.
answer
Accounting adjustments bring an asset or liability account balance to its correct amount. They also update related expense or revenue accounts. Every adjusting entry affects one or more income statement accounts and one or more balance sheet accounts. An adjusting entry never affects cash.
question
Compute profit margin and describe its use in analyzing company performance.
answer
Profit margin is defined as the reporting period's net income divided by its net sales. Profit margin reflects on a company's earnings activities by showing how much income is in each dollar of sales.
question
Compute the current ratio and describe what it reveals about a company's financial condition.
answer
A company's current ratio is defined as current assets divided by current liabilities. We use it to evaluate a company's ability to pay its current liabilities
question
Prepare and explain adjusting entries.
answer
Prepaid expenses refer to items paid for in advance of receiving their benefits. Prepaid expenses are assets. Adjusting entries for prepaids involve increasing (debiting) expenses and decreasing (crediting) assets. Unearned (or prepaid) revenues refer to cash received in advance of providing products and services. Unearned revenues are liabilities. Adjusting entries for unearned revenues involve increasing (crediting) revenues and decreasing (debiting) unearned revenues. Accrued expenses refer to costs incurred in a period that are both unpaid and unrecorded. Adjusting entries for recording accrued expenses involve in creasing (debiting) expenses and increasing (crediting) liabilities. Accrued revenues refer to revenues earned in a period that are both unrecorded and not yet received in cash. Adjusting entries for recording accrued revenues involve increasing (debiting) assets and increasing (crediting) revenues.
question
Explain and prepare an adjusted trial balance.
answer
An adjusted trial balance is a list of accounts and balances prepared after recording and posting adjusting entries. Financial statements are often prepared from the adjusted trial balance
question
Prepare financial statements from an adjusted trial balance.
answer
Revenue and expense balances are reported on the income statement. Asset, liability, and equity balances are reported on the balance sheet. We usually prepare statements in the following order: income statement, statement of retained earnings, balance sheet, and statement of cash flows.
question
Describe and prepare closing entries.
answer
Closing entries involve four steps: (1) close credit balances in revenue (and gain) accounts to Income Summary, (2) close debit balances in expense (and loss) accounts to Income Summary, (3) close Income Summary to retained earnings, and (4) close dividends account to retained earnings.
question
Explain and prepare a post-closing trial balance.
answer
A postclosing trial balance is a list of permanent accounts and their balances after all closing entries have been journalized and posted. Its purpose is to verify that (1) total debits equal total credits for permanent accounts and (2) all temporary accounts have zero balances.
question
Explain the alternatives in accounting for prepaids.
answer
Charging all prepaid expenses to expense accounts when they are purchased is acceptable. When this is done, adjusting entries must transfer any unexpired amounts from expense accounts to asset accounts. Crediting all unearned revenues to revenue accounts when cash is received is also acceptable. In this case, the adjusting entries must transfer any unearned amounts from revenue accounts to unearned revenue accounts.
question
An organization can adopt a ___consisting of any 12 consecutive months. It is also acceptable to adopt an annual reporting period of ___ weeks.
answer
fiscal year 52
question
Companies experiencing seasonal variations in sales often choose a ___ end, which is when sales activities are at their lowest level for the year.
answer
natural business year
question
After external transactions and events are recorded, several accounts still need adjustments before their balances appear in financial statements. This need arises because internal transactions and events remain unrecorded. ___uses the adjusting process to recognize revenues when earned and expenses when incurred (matched with revenues).
answer
Accrual basis accounting
question
___recognizes revenues when cash is received and records expenses when cash is paid. This means that cash basis net income for a period is the difference between cash receipts and cash payments. Cash basis accounting is not consistent with generally accepted accounting principles (neither U.S. GAAP nor IFRS).
answer
Cash basis accounting
question
Describe a company's annual reporting period.
answer
An annual reporting (or accounting) period covers one year and refers to the preparation of annual financial statements. The annual reporting period is not always a calendar year that ends on December 31. An organization can adopt a fiscal year consisting of any consecutive 12 months or 52 weeks.
question
Why do companies prepare interim financial statements?
answer
Interim financial statements (covering less than one year) are prepared to provide timely information to decision makers.
question
What two accounting principles most directly drive the adjusting process?
answer
The revenue recognition principle and the expense recognition (matching) principle lead most directly to the adjusting process.
question
Is cash basis accounting consistent with the matching principle? Why or why not?
answer
No. Cash basis accounting is not consistent with the matching principle because it reports revenue when received, not necessarily when earned, and expenses when paid, not necessarily in the period when the expenses were incurred as a result of the revenues earned.
question
If your company pays a $4,800 premium on April 1, 2011, for two years' insurance coverage how much insurance expense is reported in 2012 using cash basis accounting?
answer
No expense is reported in 2012. Under cash basis accounting, the entire $4,800 is reported as an expense in April 2011 when the premium is paid.
question
Adjusting accounts is a three-step process:
answer
Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. Step 3: Record an adjusting entry to get from step 1 to step 2. Framework
question
an ____ is made at the end of an accounting period to reflect a transaction or event that is not yet recorded. Each ___affects one or more income statement accounts and one or more balance sheet accounts (but never the Cash account).
answer
adjusting entry (answer for both)
question
_____ refer to items paid for in advance of receiving their benefits. ____ are assets. When these assets are used, their costs become expenses. Adjusting entries for prepaids increase expenses and decrease assets as shown in the T-accounts
answer
Prepaid expenses (answer for both)
question
Prepaid Insurance. We use our three-step process for this and all accounting adjustments
answer
Step 1: We determine that the current balance of FastForward's prepaid insurance is equal to its $2,400 payment for 24 months of insurance benefits that began on December 1, 2011. Step 2: With the passage of time, the benefits of the insurance gradually expire and a portion of the Prepaid Insurance asset becomes expense. For instance, one month's insurance coverage expires by December 31, 2011. This expense is $100, or 1/24 of $2,400, which leaves $2,300. Step 3: The adjusting entry to record this expense and reduce the asset, along with T-account postings.
question
____ provide information for most daily transactions, and in many businesses the recordkeepers record them. Adjustments require more knowledge and are usually handled by senior accounting professionals.
answer
Source documents
question
Recording ____ early overstates current-period revenue and income; recording it late understates current-period revenue and income.
answer
revenue
question
Recording ____ early overstates current-period expense and understates current-period income; recording it late understates current period expense and overstates current-period income.
answer
expense
question
Supplies are a prepaid expense requiring adjustment.
answer
Step 1: FastForward purchased $9,720 of supplies in December and some of them were used during this month. When financial statements are prepared at December 31, the cost of supplies used during December must be recognized. Step 2: When FastForward computes (takes physical count of) its remaining unused supplies at December 31, it finds $8,670 of supplies remaining of the $9,720 total supplies. The $1,050 difference between these two amounts is December's supplies expense. Step 3: The adjusting entry to record this expense and reduce the Supplies asset account, along with T-account postings
question
A special category of prepaid expenses is ____, which refers to long term tangible assets used to produce and sell products and services. _____ are expected to provide benefits for more than one period. Examples of ____are buildings, machines, vehicles, and fixtures. All ____, with a general exception for land, eventually wear out or decline in usefulness. The costs of these assets are deferred but are gradually reported as expenses in the income statement over the assets' useful lives (benefit periods).
answer
plant assets (answer for all blanks)
question
____ is the process of allocating the costs of these assets over their expected useful lives. ____ expense is recorded with an adjusting entry similar to that for other prepaid expenses.
answer
Depreciation Step 1: FastForward purchased equipment for $26,000 in early December to use in earning revenue. This equipment's cost must be depreciated. Step 2: The equipment is expected to have a useful life (benefit period) of four years and to be worth about $8,000 at the end of four years. This means the net cost of this equipment over its useful life is $18,000 ($26,000 - $8,000). We can use any of several methods to allocate this $18,000 net cost to expense. FastForward uses a method called straight-line depreciation, which allocates equal amounts of the asset's net cost to depreciation during its useful life. Dividing the $18,000 net cost by the 48 months in the asset's useful life gives a monthly cost of $375 ($18,000y48). Step 3: The adjusting entry to record monthly depreciation expense, along with T-account postings
question
____ allocates equal amounts of the asset's net cost to depreciation during its useful life.
answer
straight-line depreciation Ex:$26,000 equipment with $8,000 expected value at end of 4yr benefit period (26,000 - $8000 = $18,000/48 months = $375) Answer: Depreciation expense 375 (debit) Accumulated Deprepreciation 375(credit)
question
The ____ requires an asset to be initially recorded at acquisition cost. Depreciation causes the asset's book value (cost less accumulated depreciation) to decline over time.
answer
cost principle
question
A is ____ an account linked with another account, where the ____ has a normal balance opposite of the account it is linked with. It is reported as a subtraction from that other account's balance. For instance,the____of Accumulated Depreciation — Equipment is subtracted from the Equipment account in the balance sheet. This____ allows balance sheet readers to know both the full costs of assets and the total depreciation.
answer
contra account (answer to all blanks)
question
The term ____ refers to cash received in advance of providing products and services. ____, also called deferred revenues, are liabilities.
answer
unearned revenues - When cash is accepted, an obligation to provide products or services is accepted. As products or services are provided, the unearned revenues become earned revenues. Adjusting entries for unearned revenues involve increasing revenues and decreasing unearned revenues
question
____ refer to costs that are incurred in a period but are both unpaid and unrecorded. ____ must be reported on the income statement of the period when incurred. Adjusting entries for recording ____ involve increasing expenses and increasing liabilities. This adjustment recognizes expenses incurred in a period but not yet paid.
answer
Accrued expenses Note: Common examples of accrued expenses are salaries, interest, rent, and taxes.
question
The term ____ refers to revenues earned in a period that are both unrecorded and not yet received in cash (or other assets). An example is a technician who bills customers only when the job is done. If one-third of a job is complete by the end of a period, then the technician must record one-third of the expected billing as revenue in that period — even though there is no billing or collection. The adjusting entries for accrued revenues increase assets and increase revenues
answer
accrued revenues
question
The process of ____is intended to bring an asset or liability account balance to its correct amount. It also updates a related expense or revenue account. This is necessary for transactions and events that extend over more than one period.
answer
adjusting accounts Note: Adjusting entries are posted like any other entry.
question
If an adjusting entry for accrued revenues of $200 at year-end is omitted, what is this error's effect on the year-end income statement and balance sheet?
answer
If the accrued revenues adjustment of $200 is not made, then both revenues and net income are understated by $200 on the current year's income statement, and both assets and equity are understated by $200 on the balance sheet.
question
What is a contra account? Explain its purpose
answer
A contra account is an account that is subtracted from the balance of a related account. Use of a contra account provides more information than simply reporting a net amount.
question
What is an accrued expense? Give an example.
answer
An accrued expense is a cost incurred in a period that is both unpaid and unrecorded prior to adjusting entries. One example is salaries earned but not yet paid at period-end.
question
Describe how an unearned revenue arises. Give an example
answer
An unearned revenue arises when a firm receives cash (or other assets) from a customer before providing the services or products to the customer. A magazine subscription paid in advance is one example; season ticket sales is another.
question
An ____ is a list of accounts and balances prepared before adjustments are recorded.
answer
unadjusted trial balance
question
An ____ is a list of accounts and balances prepared after adjusting entries have been recorded and posted to the ledger.
answer
adjusted trial balance
question
Steps to Prepare Financial Statements
answer
1.Prepare income statement using revenue and expense accounts from trial balance. 2.Prepare balance sheet using asset and liability accounts, and common stock, from trial balance; and pull updated retained earnings from step 2. 3.Prepare statement of retained earnings using retained earnings and dividends from trial balance; and pull net income from step 1. 4.Prepare statement of cash flows from changes in cash flows for the period (not shown).
question
Music-Mart records $1,000 of accrued salaries on December 31. Five days later, on January 5 (the next payday), salaries of $7,000 are paid. What is the January 5 entry?
answer
Salaries Payable 1,000 Salaries Expense 6,000 Cash 7,000 Paid salary including accrual from December.
question
Jordan Air has the following information in its unadjusted and adjusted trial balances. What are the adjusting entries that Jordan Air likely recorded? ..................................Unadjusted ...........Adjusted ................................Debit ...Credit.......Debit....Credit Prepaid insurance $6,200.................$5,900 Salaries payable ...............$0.........................$1,400
answer
The probable adjusting entries of Jordan Air are: Insurance Expense . . . . . . . . . . . . . . . . . . 300 Prepaid Insurance . . . . . . . . . . . . . . . 300 To record insurance expired. Salaries Expense . . . . . . . . . . . . . . . . . . . . 1,400 Salaries Payable . . . . . . . . . . . . . . . . 1,400
question
What accounts are taken from the adjusted trial balance to prepare an income statement?
answer
Revenue accounts and expense accounts.
question
In preparing financial statements from an adjusted trial balance, what statement is usually prepared second?
answer
Statement of retained earnings.
question
Temporary Accounts (closed at period-end)
answer
Revenues Expenses Dividends Income Summary
question
Permanent Accounts (not closed at period-end)
answer
Assets Liabilities Common Stock Retained Earnings
question
_____accounts accumulate data related to one accounting period. They include all income statement accounts, the dividends account, and the Income Summary account. They are ____because the accounts are opened at the beginning of a period, used to record transactions and events for that period, and then closed at the end of the period.
answer
Temporary (answer for both blanks)
question
The Four Step Closing Process
answer
1 Close income statement credit balances 2 Close income statement debit balances 3 Close income summary account 4 Close dividends account Note:The closing process applies only to temporary accounts (1.Revenue,2.Expenses,3.Income Summary,4.Dividends).
question
To record and post closing entries is to transfer the end-of-period balances in revenue, expense, and dividends accounts to the permanent retained earnings account. Closing entries are necessary at the end of each period after financial statements are prepared because _____ (2 reasons).
answer
1.Revenue, expense, and dividends accounts must begin each period with zero balances. 2. Retained earnings must reflect prior periods' revenues, expenses, and dividends.
question
The ____ is a temporary account (only used for the closing process) that contains a credit for the sum of all revenues (and gains) and a debit for the sum of all expenses (and losses). Its balance equals net income or net loss and it is transferred to retained earnings. Next the dividends account balance is transferred to retained earnings. After these closing entries are posted, the revenue, expense, dividends, and ____ accounts have zero balances. These accounts are then said to be closed or cleared.
answer
Income Summary
question
Closing Process step 1 (detailed)
answer
Step 1: Close Credit Balances in Revenue Accounts to Income Summary The first closing entry transfers credit balances in revenue (and gain) accounts to the Income Summary account. The accounts with credit balances are brought to zero by debiting them.
question
Closing Process step 2 (detailed)
answer
Step 2: Close Debit Balances in Expense Accounts to Income Summary The second closing entry transfers debit balances in expense (and loss) accounts to the Income Summary account.The expense accounts' debit balances are brought to zero by crediting them.
question
Closing Process step 3 (detailed)
answer
Step 3: Close Income Summary to Retained Earnings The third closing entry transfers the balance of the Income Summary account to retained earnings. This entry closes the Income Summary account. The Income Summary account has a zero balance after posting this entry. It continues to have a zero balance until the closing process again occurs at the end of the next period. (If a net loss occurred because expenses exceeded revenues, the third entry is reversed: debit Retained Earnings and credit Income Summary.)
question
Closing Process step 4 (detailed)
answer
Step 4: Close Dividends Account to Retained Earnings The fourth closing entry transfers any debit balance in the dividends account to retained earnings This entry gives the dividends account a zero balance, and the account is now ready to accumulate next period's dividends.
question
The 10 step accounting cycle
answer
1. Analyze - transactions Analyze transactions to prepare for journalizing. 2. Journalize - Record accounts, including debits and credits, in a journal. 3. Post - Transfer debits and credits from the journal to the ledger. 4. Prepare unadjusted trial balance - Summarize unadjusted ledger accounts and amounts. 5. Adjust Record adjustments to bring account balances up to date; journalize and post adjustments. 6. Prepare adjusted trial balance - Summarize adjusted ledger accounts and amounts. 7. Prepare statements - Use adjusted trial balance to prepare financial statements. 8. Close - Journalize and post entries to close temporary accounts. 9. Prepare post-closing trial balance - Test clerical accuracy of the closing procedures. 10. Reverse - (optional) Reverse certain adjustments in the next period.
question
What are the major steps in preparing closing entries?
answer
The major steps in preparing closing entries are to close (1) credit balances in revenue accounts to Income Summary, (2) debit balances in expense accounts to Income Summary, (3) Income Summary to retained earnings, (4) any dividends account to retained earnings.
question
Why are revenue and expense accounts called temporary? Name the types of temporary accounts.
answer
Revenue (and gain) and expense (and loss) accounts are called temporary because they are opened and closed each period. The Income Summary and Dividends accounts are also temporary.
question
What accounts are listed on the post-closing trial balance?
answer
Permanent accounts make up the post-closing trial balance Assets, Liabilities,Common Stock, Retained Earnings.
question
An ____ is one whose items are broadly grouped into assets, liabilities,and equity.
answer
unclassified balance sheet Note: Accounts contained in it include: Current assets Current liabilities Noncurrent assets Noncurrent liabilities Long-term investments Equity Plant assets Intangible assets
question
____ are cash and other resources that are expected to be sold, collected, or used within one year or the company's operating cycle, whichever is longer. Examples are cash, short-term investments, accounts receivable, short-term notes receivable, goods for sale (called merchandise or inventory), and prepaid expenses.
answer
Current assets Note: Current is also called short term, and non-current is also called long-term.
question
A second major balance sheet classification is ____investments (or noncurrent) . Notes receivable and investments in stocks and bonds are ____assets when they are expected to be held for more than the longer of one year or the operating cycle. Land held for future expansion is a ____ investment because it is not used in operations.
answer
long-term
question
____ are tangible assets that are both long-lived and used to produce or sell products and services. Examples are equipment, machinery, buildings, and land that are used to produce or sell products and services. The order listing for plant assets is usually from most liquid to least liquid such as equipment and machinery to buildings and land.
answer
Plant assets Note: Plant assets are also called fixed assets; property, plant and equipment; or long-lived assets.
question
____are long-term resources that benefit business operations, usually lack physical form, and have uncertain benefits. Examples are patents, trademarks, copyrights, franchises, and goodwill. Their value comes from the privileges or rights granted to or held by the owner.
answer
Intangible assets
question
____are obligations due to be paid or settled within one year or the operating cycle, whichever is longer. They are usually settled by paying out current assets such as cash. ____ often include accounts payable, notes payable, wages payable, taxes payable, interest payable, and unearned revenues. Also, any portion of a longterm liability due to be paid within one year or the operating cycle, whichever is longer, is a ____. Unearned revenues are _____ when they will be settled by delivering products or services within one year or the operating cycle, whichever is longer. ____ are reported in the order of those to be settled first.
answer
Current liabilities (answer for all blanks)
question
_____are obligations not due within one year or the operating cycle, whichever is longer. Notes payable, mortgages payable, bonds payable, and lease obligations are common ____. If a company has both short- and ____ items in each of these categories, they are commonly separated into two accounts in the ledger.
answer
Long-term liabilities (answer for all blanks)
question
____is the owner's claim on assets. The ____section for a corporation is divided into two main subsections, common stock and retained earnings.
answer
Equity
question
Classify the following assets as (1) current assets, (2) plant assets, or (3) intangible assets: (a) land used in operations, (b) office supplies, (c) receivables from customers due in 10 months, (d) insurance protection for the next 9 months, (e) trucks used to provide services to customers, (f ) trademarks.
answer
Current assets: (b), (c), (d). Plant assets: (a), (e). Item ( f ) is an intangible asset.
question
Cite at least two examples of assets classified as investments on the balance sheet
answer
Investment in common stock, investment in bonds, and land held for future expansion.
question
Explain the operating cycle for a service company.
answer
For a service company, the operating cycle is the usual time between (1) paying employees who do the services and (2) receiving cash from customers for services provided.
question
What is the Profit Margin formula?
answer
Net income/ Net sales
question
what is the current ratio formula?
answer
Current Assets/ Current Liabilities Note: The current ratio is one measure of a company's ability to pay its short-termobligations.
question
____ are optional. They are recorded in response to accrued assets and accrued liabilities that were created by adjusting entries at the end of a reporting period.
answer
Reversing entries
question
What is the Return on Assets Formula?
answer
Net Income/ Average total assets
question
What is the Debt Ratio?
answer
Total Liabilities/ Total Assets
