3.11: Key terms

Accounting period A time period normally of one month, one quarter, or one year into which an entity’s life is arbitrarily divided for financial reporting purposes.

Accounting year An accounting period of one year. The accounting year may or may not coincide with the calendar year.

Accrual basis of accounting Recognizes revenues when sales are made or services are performed, regardless of when cash is received. Recognizes expenses as incurred, whether or not cash has been paid out.

Accrued assets and liabilities Assets and liabilities that exist at the end of an accounting period but have not yet been recorded; they represent rights to receive, or obligations to make, payments that are not legally due at the balance sheet date. Examples are accrued fees receivable and salaries payable.

Accrued items Adjusting entries relating to activity on which no data have been previously recorded in the accounts. Also, see accrued assets and liabilities.

Accrued revenues and expenses Other names for accrued assets and liabilities.

Accumulated depreciation account A contra asset account that shows the total of all depreciation recorded on the asset up through the balance sheet date.

Adjusting entries Journal entries made at the end of an accounting period to bring about a proper matching of revenues and expenses; they reflect economic activity that has taken place but has not yet been recorded. Adjusting entries are made to bring the accounts to their proper balances before financial statements are prepared.

Book value For depreciable assets, book value equals cost less accumulated depreciation.

Calendar year The normal year, which ends on December 31.

Cash basis of accounting Recognizes revenues when cash is received and recognizes expenses when cash is paid out.

Contra asset account An account shown as a deduction from the asset to which it relates in the balance sheet; used to reduce the original cost of the asset down to its remaining undepreciated cost or book value.

Deferred items Adjusting entries involving data previously recorded in the accounts. Data are transferred from asset and liability accounts to expense and revenue accounts. Examples are prepaid expenses, depreciation, and unearned revenues.

Depreciable amount The difference between an asset’s cost and its estimated residual value.

Depreciable asset A manufactured asset such as a building, machine, vehicle, or equipment on which depreciation expense is recorded.

Depreciation accounting The process of recording depreciation expense.

Depreciation expense The amount of asset cost assigned as an expense to a particular time period.

Depreciation formula (straight-line):

Estimated residual value (scrap value) The amount that the company can probably sell the asset for at the end of its estimated useful life.

Estimated useful life The estimated time periods that a company can make use of the asset.

Fiscal year An accounting year of any 12 consecutive months that may or may not coincide with the calendar year. For example, a company may have an accounting, or fiscal, year that runs from April 1 of one year to March 31 of the next.

Matching principle An accounting principle requiring that expenses incurred in producing revenues be deducted from the revenues they generated during the accounting period.

Prepaid expense An asset awaiting assignment to expense. An example is prepaid insurance. Assets such as cash and accounts receivable are not prepaid expenses.

Service potential The benefits that can be obtained from assets. The future services that assets can render make assets “things of value” to a business.

Trend percentages Calculated by dividing the amount of an item for each year by the amount of that item for the base year.

Unearned revenue Assets received from customers before services are performed for them. Since the revenue has not been earned, it is a liability, often called revenue received in advance or advances by customers.

Self-test

True-false

Indicate whether each of the following statements is true or false:

Every adjusting entry affects at least one income statement account and one balance sheet account.

All calendar years are also fiscal years, but not all fiscal years are calendar years.

The accumulated depreciation account is an asset account that shows the amount of depreciation for the current year only.

The Unearned Delivery Fees account is a revenue account.

If all of the adjusting entries are not made, the financial statements are incorrect.

Multiple-choice

Select the best answer for each of the following questions.

An insurance policy premium of USD 1,200 was paid on 2010 September 1, to cover a one-year period from that date. An asset was debited on that date. Adjusting entries are prepared once a year, at year-end. The necessary adjusting entry at the company’s year-end, 2010 December 31, is:

The Supplies on Hand account has a balance of USD 1,500 at year-end. The actual amount of supplies on hand at the end of the period was USD 400. The necessary adjusting entry is:

A company purchased a truck for USD 20,000 on 2010 January 1. The truck has an estimated residual value of USD 5,000 and is expected to last five years. Adjusting entries are prepared only at year-end. The necessary adjusting entry at 2010 December 31, the company’s year-end, is:

A company received cash of USD 24,000 on 2010 October 1, as subscriptions for a one-year period from that date. A liability account was credited when the cash was received. The magazine is to be published by the company and delivered to subscribers each month. The company prepares adjusting entries at the end of each month because it prepares financial statements each month. The adjusting entry the company would make at the end of each of the next 12 months would be:

When a company earns interest on a note receivable or on a bank account, the debit and credit are as follows:

If USD 3,000 has been earned by a company’s workers since the last payday in an accounting period, the necessary adjusting entry would be:

a. Debit an expense and credit a liability.

b. Debit an expense and credit an asset.

c. Debit a liability and credit an asset.

d. Debit a liability and credit an expense.

Now turn to “Answers to self test” at the back of the book to check your answers.