Chapter 2 ACC 250

What is the basic accounting equation?

Assets = Liabilities + Stockholders' Equity.

What is the expanded accounting equation?

Assets = Liabilities + Paid-in Capital + Beginning Retained Earnings + Revenue + Gains − Expenses − Losses − Dividends.

What happens to the accounting equation when revenue is earned?

Stockholders' equity increases.

What happens to the accounting equation when an expense is incurred?

Stockholders' equity decreases.

What happens to stockholders' equity when dividends are paid?

Stockholders' equity decreases.

What is the general ledger?

A collection of all accounts and their balances, including transaction details.

What is double-entry accounting?

A system in which every transaction affects at least two accounts and total debits equal total credits.

What is a journal entry?

A chronological record of a transaction showing its debits and credits.

What does posting mean?

Transferring information from journal entries to the general ledger accounts.

What is an unadjusted trial balance?

A list of account balances before adjusting entries, used to check that total debits equal total credits.

What is the purpose of the accounting cycle?

To record, adjust, and summarize transactions, ultimately preparing financial statements.

What are the ten steps of the accounting cycle?

1. Obtain source documents. 2. Analyze transactions. 3. Record journal entries. 4. Post to ledger. 5. Prepare unadjusted trial balance. 6. Record and post adjustments. 7. Prepare adjusted trial balance. 8. Prepare financial statements. 9. Close temporary accounts at year-end. 10. Prepare post-closing trial balance.

What is a debit?

An entry on the left side of an account.

What is a credit?

An entry on the right side of an account.

What is a normal balance?

The debit or credit side that increases an account.

Which accounts have normal debit balances?

Assets, expenses, losses, and dividends.

Which accounts have normal credit balances?

Liabilities, stockholders' equity, revenues, and gains.

How do assets increase and decrease?

Increase with a debit; decrease with a credit.

How do liabilities increase and decrease?

Increase with a credit; decrease with a debit.

How does stockholders' equity increase and decrease?

Increase with a credit; decrease with a debit.

How do expenses increase and decrease?

Increase with a debit; decrease with a credit.

How do revenues increase and decrease?

Increase with a credit; decrease with a debit.

What is the normal balance of Accounts Receivable?

Debit, because it is an asset.

What is the normal balance of Accounts Payable?

Credit, because it is a liability.

What is the normal balance of Prepaid Rent?

Debit, because it is an asset.

What is the normal balance of Deferred Revenue?

Credit, because it is a liability.

What is the normal balance of Accumulated Depreciation?

Credit, because it is a contra-asset account.

What is the journal entry when common stock is issued for cash?

Debit Cash; Credit Common Stock.

What is the journal entry when money is borrowed by signing a note?

Debit Cash; Credit Notes Payable.

What is the journal entry when supplies are purchased on account?

Debit Supplies; Credit Accounts Payable.

What is the journal entry when equipment is purchased for cash?

Debit Equipment; Credit Cash.

What is the journal entry when services are provided for cash?

Debit Cash; Credit Service Revenue.

What is the journal entry when services are provided on account?

Debit Accounts Receivable; Credit Service Revenue.

What is the journal entry when a customer pays an existing account receivable?

Debit Cash; Credit Accounts Receivable.

What is the journal entry when a company pays an existing account payable?

Debit Accounts Payable; Credit Cash.

What is the journal entry when employees are paid for work performed in the current period?

Debit Salaries Expense; Credit Cash.

What is the journal entry when the current month's utilities are paid?

Debit Utilities Expense; Credit Cash.

What is the journal entry when cash is received before goods or services are delivered?

Debit Cash; Credit Deferred Revenue.

What is the journal entry when rent is paid in advance using the asset approach?

Debit Prepaid Rent; Credit Cash.

What is the journal entry when dividends are paid?

Debit Dividends; Credit Cash.

What two entries are required when inventory is sold using the perpetual inventory system?

1. Debit Cash or Accounts Receivable and credit Sales Revenue for the selling price. 2. Debit Cost of Goods Sold and credit Inventory for the cost.

Does collecting an existing account receivable create additional revenue?

No. Revenue was recorded when the sale or service occurred. Collection only increases Cash and decreases Accounts Receivable.

What is an adjusting journal entry (AJE)?

An entry made at the end of an accounting period to update accounts before preparing financial statements.

What are the three categories of adjusting entries in your notes?

Prepayments, accruals, and estimates.

What are prepayments?

Transactions where cash is received or paid before the related revenue is earned or expense is incurred.

What are accruals?

Transactions where revenue is earned or an expense is incurred before cash is received or paid.

What are estimates?

Adjustments involving estimated amounts, such as depreciation expense or bad debt expense.

Do adjusting entries debit or credit Cash?

No. Adjusting entries never directly debit or credit Cash.

What two types of accounts are generally affected by an adjusting entry?

One balance sheet account and one income statement account.

Why are adjusting entries necessary?

To ensure revenues and expenses are reported in the correct accounting period and balance sheet accounts are updated.

What happens after adjusting entries are recorded and posted?

An adjusted trial balance is prepared.

What is an adjusted trial balance?

A list of account balances after adjusting entries, used to prepare the financial statements.

What is a prepaid expense?

An asset arising when cash is paid before the related expense is incurred.

Give three examples of prepaid expenses.

Prepaid rent, prepaid insurance, and supplies.

What is the adjusting entry when prepaid rent expires?

Debit Rent Expense; Credit Prepaid Rent.

What is the adjusting entry for expired insurance?

Debit Insurance Expense; Credit Prepaid Insurance.

What is the adjusting entry when supplies are consumed?

Debit Supplies Expense; Credit Supplies.

How do you calculate supplies expense?

Beginning Supplies + Supplies Purchased − Ending Supplies on Hand.

How do you calculate monthly rent expense for a one-year prepaid rental agreement?

Total Prepaid Rent ÷ 12 months.

How do you calculate expired insurance expense?

Total Premium ÷ Coverage Months × Months Expired.

If the adjusting entry for an expired prepaid expense is omitted, what happens?

Assets are overstated, expenses are understated, and net income is overstated.

What is the alternative expense approach for prepaid items?

Initially record the payment as an expense, then adjust the unused portion into a prepaid asset at period-end.

What is deferred revenue?

A liability created when cash is received before goods or services are provided.

Why is deferred revenue a liability?

The company still owes goods or services to the customer.

Give three examples of deferred revenue.

Advance rent received, customer deposits, and advance subscription payments.

What is the original entry when a company receives rent in advance?

Debit Cash; Credit Deferred Rent Revenue.

What is the adjusting entry when previously deferred revenue is earned?

Debit Deferred Revenue; Credit Revenue.

How do you calculate monthly revenue earned from a one-year advance payment?

Total Advance Payment ÷ 12 months.

If the adjusting entry for earned deferred revenue is omitted, what happens?

Liabilities are overstated, revenues are understated, and net income is understated.

What is the alternative revenue approach for advance receipts?

Initially credit Revenue, then adjust the unearned portion to Deferred Revenue at period-end.

What is an accrued liability?

An expense that has been incurred but has not yet been paid.

Give three examples of accrued liabilities.

Salaries payable, interest payable, and utilities payable.

What is the adjusting entry for accrued salaries?

Debit Salaries Expense; Credit Salaries Payable.

What is the adjusting entry for accrued interest expense?

Debit Interest Expense; Credit Interest Payable.

What is the formula for simple interest?

Principal × Annual Interest Rate × Time in Years.

How is interest calculated when the period is measured in months?

Principal × Annual Interest Rate × (Number of Months ÷ 12).

Does interest expense depend on when interest is paid?

No. Under accrual accounting, interest expense is recognized as time passes.

If an adjusting entry for accrued salaries is omitted, what happens?

Liabilities are understated, expenses are understated, and net income is overstated.

If accrued interest expense is not recorded, what happens?

Liabilities are understated and net income is overstated.

What happens to stockholders' equity if accrued expenses are omitted?

Stockholders' equity is overstated because net income is overstated.

What is accrued revenue?

Revenue that has been earned but not yet received in cash or recorded.

What is the adjusting entry for accrued interest revenue?

Debit Interest Receivable; Credit Interest Revenue.

What is the adjusting entry for services earned but not yet billed?

Debit Accounts Receivable; Credit Service Revenue.

How is accrued interest revenue calculated?

Principal × Annual Interest Rate × Time in Years.

If the adjusting entry for accrued revenue is omitted, what happens?

Assets are understated, revenues are understated, and net income is understated.

What is the difference between accrued revenue and deferred revenue?

Accrued revenue is earned before cash is received; deferred revenue involves cash received before revenue is earned.

What is the difference between an accrued expense and a prepaid expense?

An accrued expense is incurred before cash is paid; a prepaid expense is paid before it is incurred.

What is depreciation?

Allocation of a depreciable asset's cost over its useful life.

What is the straight-line depreciation formula?

(Asset Cost − Salvage Value) ÷ Useful Life.

How do you calculate monthly straight-line depreciation?

Annual Depreciation Expense ÷ 12.

What is the adjusting entry for depreciation?

Debit Depreciation Expense; Credit Accumulated Depreciation.

What is accumulated depreciation?

A contra-asset account that accumulates depreciation recognized on an asset.

Does recording depreciation directly reduce the Equipment account?

No. It increases Accumulated Depreciation, which reduces the asset's carrying amount.

What happens if depreciation expense is not recorded?

Assets are overstated, expenses are understated, and net income is overstated.

Does recording depreciation involve a cash payment?

No. Depreciation is a noncash expense.

Which trial balance is used to prepare financial statements?

The adjusted trial balance.

In what order are the financial statements prepared in your Chapter 2 notes?

Income statement, statement of shareholders' equity, balance sheet, and statement of cash flows.

What does the income statement report?

Revenues, expenses, gains, and losses for an accounting period.

What does the statement of shareholders' equity report?

Changes in stockholders' equity accounts during the period.

What does the balance sheet report?

Assets, liabilities, and stockholders' equity at a specific point in time.