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Financial Accounting
Financial Accounting Unit 3
| Question | Answer |
|---|---|
| What is the revenue recognition principle? | It requires that revenue be recognized when it is earned and realizable, not necessarily when cash is received. |
| Under accrual accounting, when is revenue recorded? | When the earnings process is substantially complete and collection is reasonably assured. |
| What two conditions must be met to recognize revenue? | Goods or services are substantially delivered. Cash has been collected or collection is reasonably assured. |
| In accrual accounting, when are expenses recognized? | When incurred, regardless of when they are paid. |
| What type of accounting does the revenue recognition principle support? | Accrual-basis accounting (required under GAAP). |
| What is the key difference between accrual and cash-basis accounting? | Accrual: Records revenue/expenses when earned/incurred. Cash-basis: Records revenue/expenses when cash changes hands. |
| Is cash received before earning the revenue recognized as revenue? | No, it is recorded as unearned revenue, a liability, until the work is completed. |
| In a contract worth $20,000, if $15,000 of work is done in Year 1, how much revenue is recognized that year (even if only $2,000 was received)? | $15,000 — because that’s the economic value earned. |
| What concept requires accountants to divide a company’s life into periods like quarters or years? | The Time Period Concept. |
| What’s the difference between a fiscal year and a calendar year? | Calendar year: January 1 to December 31 Fiscal year: Any 12-month period used for reporting |
| Why does accrual accounting often require estimates? | To match revenues and expenses in the correct period, especially for depreciation, bad debts, and long-term contracts. |
| How does the revenue recognition principle support accurate income statements? | It ensures reported revenue reflects the actual value delivered to customers during the period. |
| Which accounting method is not GAAP-compliant? | Cash-basis accounting. |
| If a company performs $12,000 of services and only collects $5,000, how much revenue is recognized under accrual accounting? | $12,000 |
| What is accrual accounting? | Recording revenues and expenses when earned or incurred, not when cash is received or paid |
| What name is given to a 12-month accounting period? | Fiscal year |
| How does the time period concept impact the process of financial reporting? | Financial statements are provided on a regular basis, at least once a year. |
| What is the matching principle in accounting? | It requires that expenses be recognized in the same period as the revenues they help generate. |
| Why is the matching principle important? | It ensures an accurate measure of net income and economic performance by aligning costs with revenues. |
| What type of accounting uses the matching principle? | Accrual accounting. |
| How does the matching principle differ from cash-basis accounting? | It records expenses when incurred (not when paid), aligning with the revenues they help earn. |
| Give an example of direct matching. | Recording cost of goods sold in the same period as the related sales revenue. |
| What is systematic and rational allocation? | Allocating expenses like depreciation over multiple periods in a consistent manner. |
| What is immediate recognition? | Expensing costs (e.g., advertising, R&D) immediately when incurred if they lack a clear revenue connection. |
| How are bad debts handled under the matching principle? | Estimated bad debt expense is recognized in the same period as the related credit sales. |
| How are warranty obligations matched? | Expected future repair costs are estimated and recorded in the same period as the product sale. |
| What is the formula for net income under accrual accounting? | Recognized Revenues – Matched Expenses = Net Income |
| What principle requires expenses like rent or insurance to be spread over time? | Systematic and rational allocation under the matching principle. |
| What are the two core principles of accrual accounting? | Revenue Recognition Principle Matching Principle |
| Where and when should an expense already paid in cash be reported if it cannot be directly matched with an associated revenue? | In the income statement as an expense in the accounting period in which it is incurred |
| What is the key feature of accrual basis accounting? | Revenue and expenses are recorded when earned or incurred, not when cash is exchanged. |
| What is the key feature of cash basis accounting? | Revenue and expenses are recorded only when cash is received or paid. |
| Which method is required by GAAP? | Accrual basis accounting. |
| What does accrual accounting focus on? | Economic performance—how much value was delivered or consumed. |
| What does cash basis accounting focus on? | Cash flow—how much cash came in or went out. |
| Why does accrual accounting provide a more accurate picture of profitability? | Because it matches revenues and related expenses in the same period. |
| Is cash basis accounting acceptable under GAAP? | No, it is not GAAP-compliant for most larger businesses. |
| Who typically uses cash basis accounting? | Small businesses or sole proprietors. |
| What is one weakness of the cash basis method? | It misses unpaid obligations and earned-but-uncollected revenue. |
| What financial statement is still important even with accrual accounting? | The statement of cash flows, which shows liquidity. |
| When is revenue recognized under accrual basis? | When it is earned (services performed or goods delivered). |
| When are expenses recognized under accrual basis? | When they are incurred, not when paid. |
| Which statement is correct? | Accrual basis accounting provides a more accurate picture of a company’s profitability. |
| In which type of business would accrual basis accounting result in the same income measure as cash basis accounting? | A small business, in which all sales amounts are collected in cash at the time of the sale and all expenses are paid in cash immediately |
| What is the purpose of adjusting journal entries? | To update financial records before preparing financial statements, ensuring accuracy under accrual accounting. |
| Do adjusting entries ever involve cash? | No, adjusting entries never include cash. |
| What types of accounts are always involved in adjusting entries? | One balance sheet account and one income statement account. |
| What principle does adjusting entries help enforce? | Both the revenue recognition and matching principles. |
| What are the three steps for making an adjusting entry? | Fix the balance sheet Fix the income statement Ensure no cash is involved |
| What is an example of an unrecorded receivable adjusting entry? | Debit: Accounts Receivable Credit: Revenue |
| What is an example of an unrecorded liability adjusting entry? | Debit: Wages Expense Credit: Wages Payable |
| How is a prepaid insurance adjustment recorded after use? | Debit: Insurance Expense Credit: Prepaid Insurance |
| What is the adjusting entry for unearned revenue after some service is performed? | Debit: Unearned Revenue Credit: Revenue |
| Why are adjusting entries necessary in accrual accounting? | To match revenues and expenses to the period in which they are earned or incurred, not when cash is exchanged. |
| What kind of entry is this? Debit: Rent Expense $5,000 Credit: Prepaid Rent $5,000 | A prepaid expense adjustment (systematic allocation of used rent). |
| Which financial statements are affected by adjusting entries? | The balance sheet and the income statement. |
| What’s the key rule to remember about adjusting entries and timing? | They are made at the end of the accounting period to reflect accurate performance. |
| What are real (permanent) accounts? | Accounts that carry balances forward from period to period. They include assets, liabilities, and owners’ equity. |
| What are nominal (temporary) accounts? | Accounts used to track activity for the current period only—revenues, expenses, and dividends. |
| Where do real accounts appear? | On the balance sheet. |
| Where do nominal accounts appear? | On the income statement (revenues, expenses) and the statement of retained earnings (dividends). |
| Why are nominal accounts closed at the end of a period? | To reset their balances to zero and transfer results to Retained Earnings. |
| What does the closing process achieve? | Zeroes out nominal accounts Transfers net income/loss and dividends to Retained Earnings |
| Why are revenues credited? | Revenues increase equity, and increases in equity are credited. |
| Why are expenses and dividends debited? | They decrease equity, and decreases in equity are debited. |
| When are closing entries made? | After the financial statements are prepared at the end of the accounting period. |
| What is the final destination for all nominal account balances? | Retained Earnings, a real (permanent) account. |
| What are the two main goals of closing entries? | Start the new period with zero balances in nominal accounts Reflect performance in Retained Earnings |
| Which accounts are never closed? | Assets, liabilities, and equity accounts (except for subcategories like dividends) |
| Which one of these items is a nominal account? | Sales Revenue |
| Which item is closed to a zero balance at the end of each accounting period? | Cost of Goods Sold |
| At the end of a period, what happens to balances existing in real accounts? | They are carried forward to the next period. |
| What is the purpose of closing entries? | To reset revenues, expenses, and dividends to zero and transfer their balances to Retained Earnings. |
| Which accounts are closed at year-end? | Only nominal (temporary) accounts: Revenues Expenses Dividends |
| What is the normal balance of revenue accounts? | Credit |
| How are revenue accounts closed? | Debit revenue accounts; credit Retained Earnings. |
| What is the normal balance of expense accounts? | Debit |
| How are expense accounts closed? | Credit expense accounts; debit Retained Earnings. |
| Are dividends expenses? | No, but they reduce equity and are closed to Retained Earnings. |
| How are dividends closed? | Credit Dividends; debit Retained Earnings. |
| What effect does net income have on Retained Earnings? | Increases Retained Earnings. |
| What effect do dividends have on Retained Earnings? | Decrease Retained Earnings. |
| In a proprietorship or partnership, what account receives closing entries? | The Capital account, not Retained Earnings. |
| What does the acronym “RED” stand for in closing entries? | Revenue, Expense, Dividends — the accounts that are closed. |
| What type of accounts are NOT closed at the end of the period? | Real (permanent) accounts: Assets, Liabilities, and Retained Earnings. |
| When are closing entries made? | After the financial statements are prepared, at the end of the accounting period. |
| At the end of the year, before any closing entries are made, which account typically has a debit balance? | Dividends |
| What is the purpose of the post-closing trial balance? | To ensure only real (permanent) accounts remain and that debits equal credits after closing entries are posted. |
| When is a post-closing trial balance prepared? | After all closing entries have been journalized and posted. |
| Which accounts appear in the post-closing trial balance? | Only real (permanent) accounts: Assets Liabilities Capital Stock Updated Retained Earnings |
| Which accounts do NOT appear in the post-closing trial balance? | Nominal (temporary) accounts: Revenues Expenses Dividends |
| What is the formula for calculating ending Retained Earnings? | Ending Retained Earnings = Beginning Retained Earnings + Net Income − Dividends |
| Why don’t we close real accounts like Inventory or Accounts Payable? | Because they are permanent accounts and their balances carry forward to the next period. |
| What are the three types of nominal accounts that get closed? | Revenues (Credit → closed with a Debit) Expenses (Debit → closed with a Credit) Dividends (Debit → closed with a Credit) |
| What is the result of the closing process? | Nominal accounts are reset to zero Balances are transferred to Retained Earnings Books are ready for a new accounting period |
| How does the post-closing trial balance help confirm the accuracy of closing entries? | It shows that all temporary accounts are closed and the accounting equation remains balanced. |
| What is one account that does not get closed even though it has “revenue” in the name? | Unearned Revenue — it is a liability and remains open. |
| Which account is shown in a post-closing trial balance? | Cash |
| How is the ending Retained Earnings balance computed? | Beginning Retained Earnings + Cash − Total Liabilities |
| At the end of the year, what amount is reflected in the Retained Earnings balance before the closing entries are made and posted? | Beginning Retained Earnings |
| What is the purpose of using spreadsheets in accounting? | To organize data, automate calculations, reduce input errors, and streamline financial processes like closing entries and trial balances. |
| What application is commonly used by accountants for closing and reporting tasks? | Microsoft Excel (or similar spreadsheet software). |
| What type of accounts are closed using Excel in this lesson? | Nominal (temporary) accounts: Revenues, Expenses, and Dividends. |
| In Excel, how do you close revenue accounts? | Debit the revenue accounts to zero them out. |
| In Excel, how do you close expense accounts? | Credit the expense accounts to zero them out. |
| What is done with the net income (or loss) from closed accounts in Excel? | It is posted to Retained Earnings. |
| How do you close Dividends in Excel? | Debit Retained Earnings Credit Dividends Use formulas to reference values. |
| What Excel feature helps reduce typing errors when selecting accounts? | Data Validation → List dropdowns using the adjusted trial balance as the source. |
| What formula is used to calculate Ending Retained Earnings in Excel? | = Beginning Retained Earnings + Net Income – Dividends |
| What does a post-closing trial balance include? | Only real (permanent) accounts like Assets, Liabilities, Capital Stock, and updated Retained Earnings. |
| What accounts should not appear in the post-closing trial balance? | Revenues, Expenses, and Dividends (they’re nominal accounts and already closed). |
| How can Excel formulas improve closing accuracy? | By pulling values directly from other cells, reducing manual entry and errors. |
| Which Excel spreadsheet tool is used to create a drop-down list in a cell? | Data Validation |
Created by:
heavenlypure
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