Chapter 4 - Accounting

1. What is the periodicity assumption of GAAP?

The financial activities of a business can be divided into distinct time periods such as monthly, quarterly, or annually. 

2. What is the revenue recognition principle of GAAP? 

• Requires that companies recognize revenue in the accounting period in which the performance obligation is satisfied

• Performance obligation is satisfied by performing a service or providing a good to a customer

3. What is the expense recognition principle of GAAP?

• In recognizing expenses, a simple rule is: 

• “Let the expenses follow the revenues.”

• Requires that companies recognize expenses in the period when they make efforts (consume assets or incur liabilities) to generate revenue

• Tied to revenue recognition

• Sometimes referred to as matching

• Critical issue in expense recognition 

  • Is determining when the expense makes its contribution to revenue

  • May not be the same period the expense is paid

4. It takes money to make money means what, in your own words? 

In order to make money, you have to invest and spend your money in order to grow your income and profit. 

5. What is an adjusting entry? Why are they made? 

An adjusting entry is a journal entry made at the end of an accounting period to update the accounts and ensure that they reflect the correct balances.

6. What would the journal entry of accrued revenue look like?

Date Accounts Receivable [Amount]

Date Revenue [Amount]

7. What is the equation to calculate interest? 

Interest expense = Face value × interest rate × Time period 

8. What will the time period be for a loan with interest? 

Short-term: repaid in one year or less 

Medium-term: repaid in one to five years 

Long-term: repaid more than five years and up to 30 years or more 

9. How do you calculate book value? 

Book value = total assets - total liabilities 

10. How many steps are in the accounting cycle?

9 steps in the accounting cycle. 

11. What step is to prepare financial statements? 

Step 6. 

12. How often do steps 8 & 9 occur? 

Step 8: annually 

Step 9: monthly or quarterly 

13. What is meant by a temporary and permanent account? 

Temporary accounts are used to track financial transactions for a specific period. Permanent accounts track the ongoing financial position of a company over multiple periods. 

14. Give an example of a permanent account.

Asset accounts (cash, accounts receivable, equipment.)

15. Give an example of a temporary account. 

Revenue accounts (sales revenue) 

16. What is a fiscal year? 

A fiscal year is a 12-month period and it can start on any date and end 12 months later. 

17. Before accrued revenue is adjusted what will assets & revenue look like in terms of overstated vs. understated?

The accounts will likely be understated.

18. What does it mean to be understated?

The reported value is lower than the actual value or what it should be. 

19. What does it mean to be overstated?

The reported value is higher than the actual value of what it should be. 

20. Before unearned revenue is adjusted what will liabilities & revenue look like in terms of overstated vs. understated?

21. What is unearned revenue classified as?

A liability. 

22. What is accumulated depreciation?

• Is the process of allocating the cost of a long-lived asset to expense over its useful life 

• Follows the expense recognition principle

• Is an allocation concept, not a valuation concept

23. What financial statements are affected with adjusting entries?

Income statement and balance sheet. 

24. What would a trial balance be in balance, but not be correct?

Errors in posting, missing an entire transaction, transposition errors, incorrect account balances, double posting, incorrect classification, not adjusting for accruals and deferrals. 

25. What does a worksheet look like? What does a worksheet do?

26. What is accrual basis of accounting?

• Requires that companies: 

  • Follow the revenue recognition principle 

    • Recognize revenues when they satisfy the performance obligation even if cash was not received

  • Follow the expense recognition principle 

    • Recognize expenses when incurred even if cash was not paid

27. Which basis of accounting corresponds to GAAP?

Accrual basis accounting. 

28. What is cash basis accounting?

• Occurs when companies 

  • Record revenue at the time they receive cash

  • Record expenses at the time they pay out cash

  • Not in accordance with generally accepted accounting principles (GAAP)

  • Fails to record revenue for a company that has performed services but has not yet received payment

29. What is depreciation expense?

• Allocates an asset’s cost to the period in which it is used

• Does not attempt to report the actual change in the value of the asset

30. What are typical accounting periods?

Monthly, quarterly, annually 

31. What is a performance obligation?

A performance obligation is a commitment in a contract where a company promises to deliver goods or services to a customer.

32. Suppose that Best Buy places an order for computers with Microsoft on December 17. The computers are delivered on December 20. Best Buy receives the invoice on December 21 and pays it on December 29. On what date does Microsoft satisfy its performance obligation?

December 20 since the computers were delivered to the customer. 

33. How often must a business file financial statements with the IRS? 

Monthly, quarterly, or annually. 

34. How does transparency relate to earnings?

Investors, stakeholders, and regulators rely on clear financial statements to assess a company’s financial health and probability. Furthermore, this decides if they would like to invest into a company based on the accuracy of the company’s earnings. 

35. What is the difference between a post closing trial balance and a regular trial balance?

• A regular trial balance is prepared before closing and includes all accounts 

• A post-closing trial balance is prepared after closing entries, so it only contains permanent accounts (assets, liabilities, and equity). 

36. What are the steps in the accounting cycle?

Identify and analyze financial transactions, journalize transactions, post entries into ledger accounts, prepare a trial balance, make adjusting entries, adjust trial balance, prepare financial statements, closing entries, and post-closing trial balance. 

37. What does Face Value stand for?

The original value of a financial instrument as stated by the person who issued them (bonds, stocks).

38. The adjusting entry for accrued salaries requires a debit to what account?

Salaries expense. 

39. What is an accounting worksheet? What purpose does it serve? 

An accounting worksheet is a tool used by accountants to help organize financial data and ensure accurate reporting before preparing financial statements. It is typically a spreadsheet that includes various columns for adjusting entries, trial balances, and financial statement preparation.

• Helps prepare financial statements

• Ensures accuracy 

• Structures adjusting entries 

• Assists in closing entries