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Accounting 201 Chapter 3

Time Period Assumption
Accountants divide the economic life of a business into artificial time periods:
month,
a quarter, or
a year
Fiscal Year
Accounting time period that is one year in length.
Calendar Year
January 1 to December 31
The time period assumption states that:
A: revenue should be recognized in the accounting period in which it is earned.
B: expenses should be matched with revenues.
C: the economic life of a business can be divided into artificial time periods.
D: the fiscal year should correspond with the calendar year.
C: the economic life of a business can be divided into artificial time periods.
Accrual-Basis Accounting
1. Transactions recorded in the periods in which the events occur.
2. Companies recognize revenues when they perform services (rather than when they receive cash).
3. Expenses are recognized when incurred (rather than when paid).
Cash-Basis Accounting
1. Revenues are recorded when cash is received.
2. Expenses are recorded when cash is paid.
3. Cash-basis accounting is not in accordance with generally accepted accounting principles (GAAP).
REVENUE RECOGNITION PRINCIPLE
Recognize revenue in the accounting period in which the performance obligation is satisfied.
EXPENSE RECOGNITION PRINCIPLE
Match expenses with revenues in the period when the company makes efforts to generate those revenues.
“Let the expenses follow the revenues.”
One of the following statements about the accrual basis of accounting is false? That statement is:
A: Events that change a company’s financial statements are recorded in the periods in which the events occur.
B: Revenue is recognized in the period in which the performance obligation is satisfied.
C: The accrual basis of accounting is in accordance with generally accepted accounting principles.
D: Revenue is recorded only when cash is received, and expenses are recorded only when cash is paid.
D: Revenue is recorded only when cash is received, and expenses are recorded only when cash is paid.
Accrual-basis accounting.
Companies record transactions in the period in which the events occur
Calendar year.
An accounting time period that starts on January 1 and ends on December 31.
Time period assumption.
Accountants divide the economic life of a business into artificial time periods.
Expense recognition principle.
Efforts (expenses) should be matched with results (revenues).
Adjusting Entries
1. Ensure that the revenue recognition and expense recognition principles are followed.
2. Necessary because the trial balance may not contain up-to-date and complete data.
3. Required every time a company prepares financial statements.
4. Will include one income statement account and one balance sheet account.
Adjusting entries are made to ensure that:
A: expenses are recognized in the period in which they are incurred.
B: revenues are recorded in the period in which services are performed.
C: balance sheet and income statement accounts have correct balances at the end of an accounting period.
D: all of the above.
D: all of the above.
Trial Balance
Type of adjusting entry where each account is analyzed to determine whether it is complete and up-to-date for financial statement purposes.
Deferrals
are expenses or revenues that are recognized at a date later than the point when cash was originally exchanged. There are two types:

1. Prepaid expenses
2. Unearned revenues.

Prepaid Expenses
Cash Payment before Expense Recorded

Adjusting entry:
Increase (debit) to an expense account and
Decrease (credit) to an asset account.

Depreciation
1. Buildings, equipment, and motor vehicles (assets that provide service for many years) are recorded as assets, rather than an expense, on the date acquired.

2. Depreciation is the process of allocating the cost of an asset to expense over its useful life.

3. Depreciation does not attempt to report the actual change in the value of the asset.

Statement Presentation
1. Accumulated Depreciation is a contra asset account (credit).

2. Appears just after the account it offsets (Equipment) on the balance sheet.

3. Book value is the difference between the cost of any depreciable asset and its accumulated depreciation

Unearned Revenue
Cash Receipt before Revenue Recorded

Results in a decrease (debit) to a liability account and an increase (credit) to a revenue account.

Accruals
are made to record:
Revenues for services performed but not yet recorded at the statement date (accrued revenues).
OR
Expenses incurred but not yet paid or recorded at the statement date (accrued expenses).
ACCRUED REVENUES
Revenue Recorded before Cash Receipt

Adjusting entry:
Increases (debits) an asset account and
Increases (credits) a revenue account

ACCRUED EXPENSES
Expense Recorded before Cash Payment

Adjusting entry:
Increase (debit) an expense account and
Increase (credit) a liability account.

Preparing the Adjusted Trial Balance
Prepared after all adjusting entries are journalized and posted.
Purpose is to prove the equality of debit balances and credit balances in the ledger.
Is the primary basis for the preparation of financial statements.
Which of the following statements is incorrect concerning the adjusted trial balance?
A: An adjusted trial balance proves the equality of the total debit balances and the total credit balances in the ledger after all adjustments are made.
B: The adjusted trial balance provides the primary basis for the preparation of financial statements.
C: The adjusted trial balance lists the account balances segregated by assets and liabilities.
D: The adjusted trial balance is prepared after the adjusting entries have been journalized and posted.
C: The adjusted trial balance lists the account balances segregated by assets and liabilities.
Financial Statements are prepared directly from the Adjusted Trial Balance. They are divided into…
1. Income Statement
2. Retained Earnings Statement
3. Balance Sheet
Monetary Unit
Requires that only those things that can be expressed in money are included in the accounting records.
Economic Entity
States that every economic entity can be separately identified and accounted for
Historical Cost
Or cost principle, dictates that companies record assets at their cost.
Fair Value
Indicates that assets and liabilities should be reported at fair value (the price received to sell an asset or settle
a liability)
Accountants divide the economic life of a business into artificial time periods because of the time period assumption.
A. True
B. False
A. True
An accounting time period that is one year in length is
A.
a calendar year.
B.
a fiscal year.
C.
an interim period.
D.
a quarterly period.
B.
a fiscal year.
The revenue recognition principle dictates that companies recognize revenue in the accounting period before the service is performed.
A. True
B. False
B. False
Which of the following statements about the accrual-basis of accounting is false?
A.
Events that change a company’s financial statements are recorded in the periods in which the events occur.
B.
Revenue is recognized in the period in which services are performed.
C.
Accrual-basis is in accordance with generally accepted accounting principles.
D.
Revenue is recorded only when cash is received, and expense is recorded only when cash is paid.
D.
Revenue is recorded only when cash is received, and expense is recorded only when cash is paid.
The principle or assumption dictating that expenses be matched with revenues is the
A.
expense recognition principle.
B.
historical cost assumption.
C.
periodicity principle.
D.
revenue recognition principle.
A.
expense recognition principle.
Under cash-basis accounting, companies record revenue only when
A.
services are performed.
B.
the performance obligation is satisfied.
C.
cash is received.
D.
it is incurred.
C.
cash is received.
Companies record an expense under cash-basis accounting only when
A.
services are performed.
B.
the performance obligation is satisfied.
C.
they pay out cash.
D.
it is incurred.
C.
they pay out cash.
On June 30, a printing shop provides $1,000 of services to a customer to custom print restaurant menus. The customer is sent a bill on July 5 for the amount due. A check in the amount of $1,000 is received from the customer on July 25. The printing shop follows GAAP and applies the revenue recognition principle. When is the $1,000 sale recognized?
A.
June 30.
B.
July 1.
C.
July 5
D.
July 25.
A.
June 30.
A company must make adjusting entries every time it prepares financial statements.
A. True
B. False
A. True
An adjusting entry always affects
A.
an expense account and a revenue account.
B.
an asset account and a liability account.
C.
an income statement account and a balance sheet account.
D.
an asset account and a revenue account.
C.
an income statement account and a balance sheet account.
Prepaid expenses are
A.
shown on the balance sheet as assets.
B.
shown on the balance sheet as liabilities.
C.
shown on the income statement as revenue.
D.
not shown on a financial statement.
A.
shown on the balance sheet as assets.
Each of the following is a major type (or category) of adjusting entries except
A.
prepaid expenses.
B.
accrued revenues.
C.
accrued expenses.
D.
earned revenues.
D.
earned revenues.
Revenues for which services are performed but not yet received in cash or recorded are called
A.
unearned revenues.
B.
prepaid revenues.
C.
interim revenues.
D.
accrued revenues.
D.
accrued revenues.
Prior to adjustment for prepaid expenses, assets are understated and expenses are overstated.
A. True
B. False
B. False
Accumulated Depreciation is an asset account.
A. True
B. False
B. False
Expenses paid in cash and recorded as assets before they are used are called
A.
accrued expenses.
B.
interim expenses.
C.
prepaid expenses.
D.
unearned expenses.
C.
prepaid expenses.
The accumulated depreciation account
A.
is a contra revenue account with a debit balance.
B.
is a contra asset account with a credit balance.
C.
is shown as an expense on the income statement.
D.
is shown on the balance sheet as a liability.
B.
is a contra asset account with a credit balance.
White Laundry Company purchased $6,500 of supplies on June 2 and recorded the purchase as an asset. On June 30, an inventory of the supplies indicated only $3,000 on hand. It is the company’s first period of operations. The adjusting entry that should be made by the company on June 30 is
A.
Debit Supplies Expense, $3,500; Credit Supplies, $3,500.
B.
Debit Supplies Expense, $3,000; Credit Supplies, $3,000.
C.
Debit Supplies, $3,500; Credit Supplies Expense, $3,500.
D.
Debit Supplies, $3,000; Credit Supplies Expense, $3,000.
A.
Debit Supplies Expense, $3,500; Credit Supplies, $3,500.
Adjustments for prepaid expenses
A.
decrease assets and increase revenues.
B.
decrease expenses and increase assets.
C.
decrease assets and increase expenses.
D.
decrease revenues and increase assets.
C.
decrease assets and increase expenses.
Adjustments for unearned revenues
A.
decrease liabilities and increase revenues.
B.
have an assets and revenues account relationship.
C.
increase assets and increase revenues.
D.
decrease revenues and decrease assets.
A.
decrease liabilities and increase revenues.
An adjusting entry that debits an expense and credits an asset is necessary for
A.
prepaid expenses.
B.
unearned revenues.
C.
accrued revenues.
D.
accrued expenses.
A.
prepaid expenses.
If an adjusting entry for depreciation is not made
A.
assets will be understated.
B.
stockholders’ equity will be understated.
C.
net income will be understated.
D.
expenses will be understated.
D.
expenses will be understated.
If the adjusting entry for unearned revenues is not made
A.
assets will be overstated.
B.
liabilities will be overstated.
C.
revenues will be overstated.
D.
net income will be overstated.
B.
liabilities will be overstated.

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