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ANSWERS
TO QUESTIONS - CHAPTER 2
1. Accrual accounting attempts to record the
effects of accounting events in the period when such events occur, regardless
of when cash is received or paid. The
goal is to match expenses with the revenues that they produce.
2. Recognition is the act of recording an
event in the financial statements. When
accruals are used, events are recognized before the associated cash is paid or
collected.
3. Deferral is the recognition of revenue or
expenses in a period after the cash consequences are realized, i.e., cash is
collected in advance of performing the service.
4. If cash is collected in advance for
services, the revenue is recognized when the services are rendered.
5. An asset source transaction increases
assets and increases either liabilities or equity.
6. The issue of common stock, which is
capital acquired from owners, increases business assets (usually cash) and
equity (common stock).
7. The recognition of revenue on account
increases the corresponding revenue account on the income statement, but does
not affect the statement of cash flows.
The cash flow statement is affected when the account is collected.
8. Asset Source Transaction Effect on Accounting
Equation
Issue of Common Stock Increases Assets, Increases
Common
Stock
Revenue Earned Increases Assets, Increases
Retained
Earnings
Borrowed Funds Increases Assets, Increases
Liabilities
9. Revenue is recognized under accrual
accounting when a revenue-producing event occurs, i.e., when the revenue is earned, even if no cash is collected at
the time of the transaction.
10. The collection of cash for accounts
receivable is an asset exchange transaction.
Only the asset side of the accounting equation is affected because one
asset account increases (cash), and another asset account decreases (accounts receivable). Total assets are unchanged.
11. If cash is collected in advance for
services, a liability is created (unearned revenue), increasing the claims side
of the accounting equation.
12. Unearned revenue is cash that has been
collected for services that have not yet been performed.
13. The recognition of expenses affects the
accounting equation by either decreasing assets or increasing liabilities
(payables) and by decreasing stockholders’ equity (retained earnings).
14. A claims exchange transaction is one where
the claims of creditors (liabilities) increase and the claims of stockholders
(retained earnings) decrease, or vice versa.
The total amount of claims is unchanged.
15. Cash payments to creditors are asset use
transactions. These transactions result
in the reduction of an asset account (cash) and the reduction of the
corresponding liability account (payables).
16. Expenses are recognized under accrual
accounting at the time the expense is incurred or resources are consumed,
regardless of when cash payment is made.
17. Net cash flows from operations on the cash
flow statement may be different from net income because of the application of
accrual accounting. Revenues and
expenses reported on the income statement may be recognized before or after the
actual collection or payment of cash that is reported on the cash flow
statement.
18. The income statement reflects the change in
net assets associated with operating a business, as shown by revenues and
expenses. Expenses may result from a decrease
in assets or an increase in liabilities.
Revenues may result from an increase in assets or a decrease in
liabilities.
19. Net income increases stockholders' claims on
business assets by increasing retained earnings.
20. A cost can be either an asset or an
expense. If the item acquired has
already been used in the process of earning revenue, its cost represents an
expense. If the item will be used in the
future to generate revenue, its cost represents an asset.
21. A cost is held in the asset account until
the item is used to produce revenue.
When the revenue is generated, the asset is converted into an expense in
order to match revenues with related expenses.
Not all costs become expenses. If
the value of an asset will not expire in the revenue-generating process, the
asset will not become an expense. For
example, the cost of land will not become an expense.
22. Supplies used during the accounting period
are recognized in a single adjusting entry at the end of the period. The amount of supplies used is determined by
subtracting the amount of supplies on hand at the end of the period from the
amount of supplies that were available for use (beginning supplies balance plus
supplies purchased).
23. An expense is a decrease in assets or an increase
in liabilities that occurs in the process of generating revenue.
24. Revenue is an increase in assets or a
decrease in liabilities that results from the operating activities of the
business.
25. The purpose of the statement of changes in
stockholders’ equity is to display the effects of business operations and stock
issued to owners and dividends paid to stockholders. It identifies the ways that an entity's
equity increased and decreased as a result of its operations and transactions
with its stockholders.
26. The purpose of the balance sheet is to
provide information about an entity's assets, liabilities, and stockholders’
equity and their relationships to each other at a particular point in
time. It provides a list of the economic
resources that the enterprise has available for its operating activities and
the claims to those resources.
27. The balance sheet is dated as of a specific
date because it shows information about an entity's assets, liabilities, and
stockholders’ equity as of that date, not measured over a time period. The statement of changes in stockholders’
equity, the income statement, and the cash flow statement reflect transactions
that occur over a period of time.
28. Assets are listed on the balance sheet in
accordance with their respective levels of liquidity (how rapidly they can be
converted to cash).
29. The statement of cash flows explains the
change in cash from one accounting period to the next. It is prepared by analyzing the cash account
and summarizing where cash came from and how it was used.
30. An adjusting entry is an entry that updates
account balances prior to preparation of the financial statements. The entry means that there is an item that
needs proper measurement on the income statement and an adjustment will reflect
the correct time period of earning or usage.
Example: entry to recognize
accrued interest revenue where the revenue has been earned but not yet
collected and therefore revenue had not yet been recorded for the time period.
31. Temporary accounts
(revenue, expense and dividends) are closed at the end of the accounting
period. It is necessary to close these
accounts so that revenue, expense and dividends can be accumulated from a
beginning balance of zero for the next period.
32. Period costs are
costs that are recognized in an accounting period. Examples of period costs include rent
expense, utilities expense, and salaries expense.
33. Salary of the tax return preparer could be
directly matched with the revenue that it produces.
34. The four stages
of the accounting cycle: Record
transactions; adjust the accounts; prepare statements; and close the temporary
accounts. The adjustment and closing
processes have been added to the cycle in this chapter. It is necessary to adjust accounts so that
the accounts will reflect the correct balances under the accrual basis of
accounting. The closing process
(transferring the balances of the temporary accounts to retained earnings) is
necessary so that the temporary accounts have a zero balance at the beginning
of the next accounting cycle.
35. The three elements of the fraud triangle are
(1) the availability of an opportunity (2) the existence of some form of
pressure leading to an incentive and (3) the capacity to rationalize.
35. An executive who
falsely certifies the company’s financial reports is subject to a fine up to $5
million and imprisonment up to 20 years.
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