Accounting Chapter 4

What is the accounting cycle?

The process from analyzing and journalizing transactions through preparing a post-closing trial balance.

What is the purpose of adjusting accounts?

To update account balances before preparing financial statements.

What is an adjusted trial balance used for?

To verify debit and credit equality after adjustments and provide balances for financial statements.

Which three statements are prepared using adjusted account balances?

Income statement, statement of stockholders’ equity, and balance sheet.

In what order are the three financial statements prepared?

Income statement → statement of stockholders’ equity → balance sheet.

Where does the net income figure flow after the income statement?

To retained earnings on the statement of stockholders’ equity.

Where does ending retained earnings appear?

In stockholders’ equity on the balance sheet.

What equation must the balance sheet satisfy?

Assets = Liabilities + Stockholders’ Equity.

Where are income statement figures obtained?

From adjusted trial balance amounts for revenues and expenses.

How are expenses ordered on the income statement in the slides?

Largest to smallest, with miscellaneous expense listed last.

What are the starting balances on the statement of stockholders’ equity?

Beginning common stock and beginning retained earnings.

How does issuing common stock affect stockholders’ equity?

It increases common stock and total stockholders’ equity.

How does net income affect retained earnings?

It increases retained earnings.

How do dividends affect retained earnings?

They decrease retained earnings.

Where do next period’s beginning equity balances come from?

The previous period’s ending common stock and retained earnings balances.

What is a classified balance sheet?

A balance sheet with subsections for assets and liabilities.

What are current assets?

Cash and other assets expected to be converted to cash, sold, or used up usually within one year or less.

What are examples of current assets?

Cash, accounts receivable, and supplies.

Why is land not a current asset?

It is a long-term asset, not normally used up or converted to cash within one year.

What are property, plant, and equipment?

Long-term fixed or plant assets such as equipment, machinery, buildings, and land.

What are liabilities?

Amounts a business owes to creditors.

What are current liabilities?

Obligations usually due within one year or less, paid from current assets.

What are long-term liabilities?

Obligations generally due in more than one year.

What is stockholders’ equity?

The stockholders’ claim to the assets of the business.

How is a statement of cash flows prepared according to the chapter?

By analyzing cash transactions and classifying them as operating, investing, or financing activities.

What method is normally used in practice to prepare the statement of cash flows?

The indirect method.

What are permanent (real) accounts?

Balance sheet accounts whose balances carry forward into future periods.

What are temporary (nominal) accounts?

Revenue, expense, and dividends accounts that are reset to zero at the end of a period.

Which accounts are closed at the end of the period?

Revenue, expense, and dividends accounts.

Which accounts are not closed?

Permanent asset, liability, and stockholders’ equity accounts.

Why are temporary accounts closed?

To begin the next period with zero balances for revenues, expenses, and dividends.

What are closing entries?

Journal entries that transfer temporary account balances to retained earnings.

What does “closing the books” mean?

The process of closing temporary accounts at the end of an accounting period.

What is the first closing entry?

Debit each revenue account, credit each expense account, and credit retained earnings for net income (or debit it for net loss).

What is the second closing entry?

Debit retained earnings and credit dividends for the dividends account balance.

When are closing entries dated?

The last day of the accounting period.

What happens to revenue accounts after closing?

Their balances become zero.

What happens to expense accounts after closing?

Their balances become zero.

What happens to the dividends account after closing?

Its balance becomes zero.

Which account receives net income in the closing process?

Retained earnings.

Which is nominal: Accounts Receivable, Accounts Payable, Rent Expense, or Common Stock?

Rent Expense; it is a temporary expense account.

What is step 1 of the accounting cycle?

Analyze and record transactions in the journal.

What is step 2 of the accounting cycle?

Post journal transactions to the ledger.

What is step 3 of the accounting cycle?

Prepare an unadjusted trial balance.

What is step 4 of the accounting cycle?

Assemble and analyze adjustment data.

What is step 5 of the accounting cycle?

Prepare an optional end-of-period spreadsheet.

What is step 6 of the accounting cycle?

Journalize and post adjusting entries.

What is step 7 of the accounting cycle?

Prepare an adjusted trial balance.

What is step 8 of the accounting cycle?

Prepare financial statements.

What is step 9 of the accounting cycle?

Journalize and post closing entries.

What is step 10 of the accounting cycle?

Prepare a post-closing trial balance.

Which step of the accounting cycle is optional?

Step 5: preparing an end-of-period spreadsheet.

What is the first action when analyzing a transaction?

Identify which accounts are affected.

After identifying affected accounts, what comes next?

Determine whether each account increases or decreases and whether to debit or credit it.

What is the purpose of the chart of accounts?

To help identify the accounts affected by transactions.

What does posting mean?

Transferring journal entry amounts to the corresponding ledger accounts.

What information is recorded when posting journal entries?

Date, debit or credit amount, journal page reference, and account number in the journal posting reference.

What does an unadjusted trial balance verify?

That total debits equal total credits before adjustments; it does not prove the ledger is error-free.

What if trial balance debits and credits are unequal?

An error has occurred and must be found and corrected.

Which four account types commonly require adjustment?

Accrued revenues, accrued expenses, unearned revenues, and prepaid expenses.

What additional expense usually requires adjustment for fixed assets other than land?

Depreciation expense.

What does each adjusting entry affect?

At least one income statement account and one balance sheet account.

What is the purpose of the optional end-of-period spreadsheet?

To show the flow from unadjusted to adjusted balances and analyze proposed adjustments.

Is the end-of-period spreadsheet a formal accounting record?

No; it is an optional analytical tool.

What is the final step before preparing financial statements?

Prepare an adjusted trial balance.

What is a post-closing trial balance?

A trial balance of permanent accounts prepared after closing entries are posted.

What is the purpose of the post-closing trial balance?

To verify that the ledger is in balance at the start of the next period.

Which accounts appear on the post-closing trial balance?

Permanent balance sheet accounts only.

Would Fees Earned appear on a post-closing trial balance?

No; it is a temporary revenue account closed to retained earnings.

Why do accountants close accounts but not “open” all of them again?

Permanent accounts stay open; temporary accounts restart automatically with new-period transactions after being reset to zero.

What is the cash basis of accounting?

Recording transactions only when cash is received or paid.

What is the accrual basis of accounting?

Recognizing revenues when earned and expenses in the period related revenue is earned.

What is the revenue recognition principle?

Record revenue when services are performed or products delivered, not necessarily when cash arrives.

What is the expense recognition principle?

Record expenses incurred to generate revenue in the same period as the related revenue.

Why does GAAP require accrual accounting?

It uses revenue and expense recognition principles to report period performance rather than just cash movement.

Which organization develops and maintains U.S. GAAP standards according to the slides?

Financial Accounting Standards Board (FASB).

What is the SEC’s role relative to FASB according to the slides?

The SEC delegated standard-setting to FASB but can override or provide guidance.

What is liquidity?

The ability to convert assets into cash.

What is solvency?

The ability of a business to pay its debts.

What is working capital?

The excess of current assets over current liabilities.

What is the working capital formula?

Working Capital = Current Assets − Current Liabilities.

If current assets are $7,745 and current liabilities are $1,390, what is working capital?

$6,355.

What does positive working capital imply in the chapter?

The business can meet its current liabilities and has short-term solvency.

What is the current ratio formula?

Current Ratio = Current Assets ÷ Current Liabilities.

If current assets are $7,745 and current liabilities are $1,390, what is the current ratio?

Approximately 5.6.

Which measure is more useful for comparisons between companies: current ratio or working capital?

Current ratio.

Why are current assets more liquid than long-term assets?

They can generally be converted to cash more readily to meet short-term obligations.

What are the six steps in completing an end-of-period spreadsheet?

Title; unadjusted trial balance; adjustments; adjusted trial balance; extend to statement columns; total columns and compute net income or loss.

When using an end-of-period spreadsheet, when are adjusting and closing entries normally journalized?

After the spreadsheet and financial statements have been prepared.

What are the three categories of cash flow activities?

Operating, investing, and financing.