Accounting Chapter 3

What is double-entry accounting?

A system where every financial transaction affects at least two accounts and is recorded with equal debits and credits, ensuring the accounting equation remains balanced.

What is the core rule of double-entry accounting?

For every transaction, total debits must equal total credits.

Why is double-entry accounting superior to the template approach?

It allows many accounts, supports complex transactions, provides detailed financial information, and scales as businesses grow.

What accounting equation must always remain balanced?

Assets = Liabilities + Shareholders’ Equity.

What is a debit?

An entry made on the left side of a T-account.

What is a credit?

An entry made on the right side of a T-account.

What is a T-account?

A visual representation of an account with debits on the left and credits on the right.

What is a normal balance?

The balance (debit or credit) an account is expected to have and the side used to record increases in that account.

What is the normal balance of asset accounts?

Debit.

How do assets increase and decrease?

Assets increase with debits and decrease with credits.

What is the normal balance of liability accounts?

Credit.

How do liabilities increase and decrease?

Liabilities increase with credits and decrease with debits.

What is the normal balance of shareholders’ equity accounts?

Credit.

What is the normal balance of revenue accounts?

Credit.

Why do revenues have a credit normal balance?

Because revenues increase retained earnings, which is part of shareholders’ equity.

What is the normal balance of expense accounts?

Debit.

Why do expenses have a debit normal balance?

Because expenses decrease retained earnings.

What is the normal balance of dividends declared?

Debit.

What effect do dividends declared have on equity?

They reduce retained earnings.

What does DEAD stand for?

Dividends, Expenses, Assets (normal debit balances).

What does CLOR stand for?

Liabilities, Owner’s Equity, Revenues (normal credit balances).

What are the two main components of shareholders’ equity?

Common Shares and Retained Earnings.

What is a contra-asset account?

An account that reduces the carrying value of a related asset and has a normal credit balance.

What is the Accumulated Depreciation account?

A contra-asset account that accumulates total depreciation on a long-term asset and has a normal credit balance.

What is carrying amount?

The value of an asset reported on the statement of financial position, equal to cost minus accumulated depreciation (and impairment losses); also called net book value.

What is liquidity?

An organization’s short-term ability to convert assets into cash to meet obligations and pay liabilities.

What is the accounting cycle?

The sequence of steps involved in measuring, recording, summarizing, and reporting accounting information.

What is a journal entry?

An entry made in the general journal to record a transaction or event.

What is a compound journal entry?

A journal entry with more than two parts, involving multiple debits and/or credits, where total debits equal total credits.

What is the general journal?

A chronological listing of all accounting events recorded in a company’s accounting system.

What is posting?

• Transferring information from journal entries in the general journal to the ledger accounts in the general ledger.

What is a general ledger account?

An individual account within the general ledger that records increases, decreases, and balances for a specific item.

What is the general ledger?

The financial records containing details of all asset, liability, equity, revenue, and expense accounts.

What is a trial balance?

A listing of all general ledger accounts and their balances used to verify that total debits equal total credits.

What is the purpose of a trial balance?

To check the mathematical accuracy of ledger postings.

Which error is NOT detected by a trial balance?

Omitted transactions or equal but incorrect postings.

What are adjusting entries?

Entries made at period end to record revenues and expenses in the correct period.

Why are adjusting entries necessary?

To follow accrual accounting and the matching principle.

Do adjusting entries involve cash?

No.

What two types of accounts are always affected by adjusting entries?

One income statement account and one balance sheet account.

What are accruals?

Adjusting journal entries required when a company recognizes revenue before cash is received or an expense before cash is paid.

What are deferrals?

Adjusting journal entries required when revenue or expense recognition occurs after cash has been received or paid.

What is depreciation?

The systematic allocation of an asset’s cost over its useful life.

What is the adjusting entry for depreciation?

Debit Depreciation Expense, Credit Accumulated Depreciation.

What is the adjusting entry for insurance used?

Debit Insurance Expense; Credit Prepaid Insurance.

What is the adjusting entry for accrued interest?

Debit Interest Expense; Credit Interest Payable.

What is double-declining-balance depreciation method?

A depreciation method that applies twice the straight-line rate to the asset’s carrying amount each period.

What is an adjusted trial balance?

A listing of all accounts and their balances after adjusting entries have been made but before closing entries are prepared.

What is the purpose of the adjusted trial balance?

To verify balances and prepare financial statements.

Which financial statements are prepared from the adjusted trial balance?

Statement of Income, Statement of Changes in Equity, Statement of Financial Position (Balance Sheet).

What are temporary accounts?

Accounts used to track revenues, expenses, and dividends during a period whose balances are closed to retained earnings at period end.

Which accounts are temporary accounts?

Revenues, Expenses, Dividends Declared.

What are permanent accounts?

Accounts whose balances carry over from one accounting period to the next; all statement of financial position accounts are permanent accounts.

Which accounts are permanent accounts?

Assets, Liabilities, Shareholders’ Equity.

What is the Income Summary account?

An optional temporary account used during closing to summarize revenues and expenses before transferring net income or loss to retained earnings.

What are closing entries?

Entries made at period end to transfer temporary account balances to retained earnings and reset them to zero.

What is the first closing entry?

Close revenues to Income Summary.

What is the second closing entry?

Close expenses to Income Summary.

What is the third closing entry?

Close Income Summary to Retained Earnings.

What is the fourth closing entry?

Close Dividends Declared to Retained Earnings.

What is a post-closing trial balance and what does it contain?

A trial balance prepared after closing entries that includes only permanent accounts.

If cash is received for services provided, which accounts are affected?

Debit Cash; Credit Service Revenue.

If supplies are purchased on account, which accounts are affected?

Debit Supplies; Credit Accounts Payable.

If rent is paid in cash, which accounts are affected?

Debit Rent Expense; Credit Cash.

If the owner invests cash into the business, which accounts are affected?

Debit Cash; Credit Common Shares.

When dividends are declared, which accounts are affected?

Debit Dividends Declared; Credit Retained Earnings.

Which financial statement is prepared first?

Statement of Income.

Where does net income appear after closing?

In Retained Earnings.

What is a chart of accounts?

A complete listing of all account names used in an accounting system.

What is the purpose of a worksheet in accounting?

A worksheet organizes and adjusts accounts before preparing financial statements, ensuring all adjustments are recorded.

What is a repayed expense?

A cost that has been paid in advance and is treated as an asset until it is used.

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Under accrual accounting, prepaid expenses are recorded as assets and expensed over time; under cash accounting, they are recognized as expenses when paid.

How does dividend declaration impact the accounting equation?

**Dividends declared** increase **liabilities** (Dividends Payable) and reduce **retained earnings** in shareholders’ equity.

How does dividend payment impact the accounting equation?

Paying dividends decreases **cash** (asset) and decreases **liabilities** (Dividends Payable).

Which side of a T-account is used to increase assets?

**Debit** side.

Which side of a T-account is used to increase liabilities?

**Credit** side.

Which side of a T-account is used to increase shareholders’ equity?

**Credit** side.

Which side of a T-account is used to increase expenses?

**Debit** side.

Which side of a T-account is used to increase revenues?

**Credit** side.

What is the normal balance of **Dividends Payable**?

**Credit** (liability account).

What is the normal balance of **Deferred Revenue**?

**Credit** (liability account).

What is the normal balance of **Bank Loan Payable**?

**Credit** (liability account).

What is the normal balance of **Wages Payable**?

**Credit** (liability account).