Financial Accounting Chapters 3 & 4 Review: Operating Decisions, Adjustments, and the Closing Process

Vocabulary flashcards covering accrual accounting, the revenue and expense recognition principles, adjusting entries, financial statement order, the closing process, and key ratios from Chapters 3 and 4.

Operating (Cash-to-Cash) Cycle

The time it takes a company to pay cash to suppliers, sell goods or services to customers, and collect cash from those customers.

Time Period (Periodicity) Assumption

The assumption that a company's long life can be divided into shorter artificial periods (such as months, quarters, or years) so that timely financial statements can be reported to decision makers.

Accrual Basis Accounting

The GAAP-required accounting method in which revenues are recognized when earned and expenses are recognized when incurred, regardless of when cash changes hands.

Cash Basis Accounting

An accounting method where revenues and expenses are recorded only when cash is received or paid; it is not GAAP-compliant and can distort the picture of actual performance in a given period.

Expenditure

Any cash outlay (e.g., buying equipment, repaying a loan); not all expenditures are expenses.

Expense

A cost incurred to generate revenue in the current period.

Revenue Recognition Principle

The accounting principle requiring revenue to be recognized when it is earned—specifically when the company satisfies its performance obligation by transferring promised goods or services to the customer—regardless of when cash is received.

Expense Recognition (Matching) Principle

The accounting principle requiring expenses to be recorded in the same period as the revenues they helped generate, rather than necessarily when cash is paid.

Net Profit Margin

A profitability ratio that measures how much of every sales dollar is kept as profit, calculated as $\text{Net Income} \div \text{Net Sales Revenue}$.

Adjusting Entries

End-of-period entries designed to bring account balances up to date under accrual accounting; they never involve cash and always affect exactly one income statement account and one balance sheet account.

Deferral Adjustments

Adjustments made when cash was already exchanged in the past, but the related revenue or expense is not yet fully recorded.

Accrual Adjustments

Adjustments made when a revenue is earned or an expense is incurred before any cash changes hands.

Prepaid Expenses

Assets recorded when cash is paid in advance; an adjusting entry moves the used-up portion to expense by debiting Expense and crediting the Prepaid Asset account.

Unearned Revenue

A liability recorded when cash is collected in advance of providing goods or services; an adjusting entry moves the earned portion to revenue by debiting Unearned Revenue and crediting Revenue.

Accumulated Depreciation

A contra-asset account used in a deferral adjustment to spread the cost of a long-lived asset over its useful life instead of reducing the asset account directly.

Accrued Expenses

Expenses that have been incurred but not yet paid or recorded (e.g., unpaid wages, interest owed); adjusted by debiting an Expense and crediting a Liability Payable.

Accrued Revenues

Revenues that have been earned but not yet billed or collected (e.g., interest earned, unbilled services); adjusted by debiting a Receivable asset and crediting Revenue.

Unadjusted Trial Balance

A list of all accounts and their balances prepared before adjusting entries are recorded, revealing which accounts still need updating.

Adjusted Trial Balance

A trial balance prepared after adjusting entries are journalized and posted to confirm that total debits still equal total credits before preparing the financial statements.

Temporary (Nominal) Accounts

Accounts that track financial activity for only one period and must be closed to zero at the end of the period, including revenues, gains, expenses, losses, and dividends.

Permanent (Real) Accounts

Balance sheet accounts—assets, liabilities, and stockholders' equity—that carry their ending balances forward to the next accounting period.

Closing Entries

Entries recorded at the end of a period that transfer all temporary account balances into Retained Earnings, resetting them to zero for the next period.

Post-Closing Trial Balance

A trial balance prepared after closing entries that contains only permanent balance sheet accounts, verifying that total debits equal total credits before the next period starts.

Quality of Earnings Ratio

A financial ratio calculated as $\text{Cash Flow from Operations} \div \text{Net Income}$, used to assess whether reported earnings are backed by actual operating cash flow rather than accounting estimates.

Nonoperating Items

Items on a classified statement of earnings related to peripheral activities rather than core operations, such as interest revenue, interest expense, and gains or losses on asset sales.

Earnings per Share (EPS)

A metric presented at the bottom of the income statement, calculated as $\text{Net Income} \div \text{Weighted-average shares outstanding}$.