Chapter 3
Adjusting Accounts and Preparing Financial Statements
1. A company’s fiscal year must correspond with the calendar year.
2. The time period assumption assumes that an organization’s activities can be divided into
specific time periods.
3. Interim statements report a company’s business activities for a one-year period.
4. A fiscal year refers to an organization’s accounting period that spans twelve consecutive
months or 52 weeks.
5. Adjusting entries are made after the preparation of financial statements.
6. Adjusting entries result in a better matching of revenues and expenses for the period.
7. Two main accounting principles used in accrual accounting are matching and full closure.
8. Adjusting entries are necessary so that asset, liability, revenue, and expense account
balances are correctly recorded.
9. The matching principle does not aim to record expenses in the same accounting period as
the revenue earned as a result of these expenses.
10. The revenue recognition principle is the basis for making adjusting entries that pertain to
unearned and accrued revenues.
11. The cash basis of accounting commonly results in financial statements that are less
comparable from period to period than the accrual basis of accounting.
12. Under the cash basis of accounting, no adjustments are made for prepaid, unearned, and
accrued items.
13. Since the revenue recognition principle requires that revenues be recorded when earned,
there are no unearned revenues in accrual accounting.
14. The matching principle requires that expenses get recorded in the same accounting period
as the revenues that are earned as a result of the expenses, not when cash is paid.
15. The cash basis of accounting is an accounting system in which revenues are recorded
when cash is received and expenses are recorded when cash is paid.
16. The cash basis of accounting recognizes revenues when cash payments from customers
are received.
17. The accrual basis of accounting recognizes revenues when cash is received from
customers.
18. The accrual basis of accounting recognizes expenses when cash is paid.
19. Recording revenues early overstates current-period income; recording revenues late
understates current period income.
20. Recording expenses early overstates current-period income; recording expenses late
understates current period income.
21. Prior to recording adjusting entries at the end of an accounting period, some accounts may
not show proper financial statement amounts even though all transactions were correctly
recorded.
22. A company paid $9,000 for a six-month insurance policy. The policy coverage began on
February 1. On February 28, $150 of insurance expense must be recorded.
23. On October 15, a company received $15,000 cash as a down payment on a consulting
contract. The amount was credited to Unearned Consulting Revenue. By October 31, 10% of
the services required by the contract were completed. The company will record consulting
revenue of $1,500 from this contract for October.
24. The accrual basis of accounting reflects the principle that revenue is recorded when it is
earned, not when cash is received.
25. The accrual basis of accounting requires adjustments to recognize revenues in the periods
they are earned and to match expenses with revenues.
26. Adjusting entries are designed primarily to correct accounting errors.
27. Adjustments are necessary to bring an asset or liability account to its proper amount and
also update a related expense or revenue account.
28. Each adjusting entry can only affect a balance sheet account.
29. Accrued expenses at the end of one accounting period are expected to result in cash
payments in a future period.
30. Accrued revenues at the end of one accounting period are expected to result in cash
payments in a future period.
31. Each adjusting entry affects only one or more income statements account and never cash.
32. Accrued expenses reflect transactions where cash is paid before a related expense is
recognized.
33. Under the accrual basis of accounting, adjustments are often made for prepaid expenses
and unearned revenues.
34. The entry to record a cash receipt from a customer when the service to be provided has not
yet been performed involves a debit to an unearned revenue account.
35. Costs incurred during an accounting period but unpaid and unrecorded are accrued
expenses.
36. An adjusting entry often includes an entry to Cash.
37. Before an adjusting entry is made to recognize the cost of expired insurance for the
period, Prepaid Insurance and Insurance Expense are both overstated.
38. Before an adjusting entry is made to accrue employee salaries, Salaries Expense and
Salaries Payable are both understated.
39. Failure to record depreciation expense will overstate the asset and understate the expense.
40. A company’s month-end adjusting entry for Insurance Expense is $1,000. If this entry is
not made then expenses are understated by $1,000 and net income is overstated by $1,000.
41. Profit margin can also be called return on sales.
42. Profit margin measures the relation of debt to assets.
43. Profit margin reflects the percent of profit in each dollar of revenue.
44. Profit margin is calculated by dividing net sales by net income.
45. Ben had total assets of $149,501,000, net income of $6,242,000, and net sales of
$209,203,000. Its profit margin was 2.98%.
46. A contra account is an account linked with another account; it is added to that account to
show the proper amount for the item recorded in the associated account.
47. If a company reporting on a calendar year basis, paid $18,000 cash on January 1 for one
year of rent in advance and adjusting entries are made at the end of each month, the balance of
Prepaid Rent as of December 1 should be $1,500.
48. Accumulated depreciation is shown on the balance sheet as a subtraction from the cost of
its related asset.
49. A salary owed to employees is an example of an accrued expense.
50. In accrual accounting, accrued revenues are recorded as liabilities.
51. Depreciation expense is an example of an accrued expense.
52. Earned but uncollected revenues are recorded during the adjusting process with a credit to
a revenue account and a debit to an expense account.
53. Depreciation expense for a period is the portion of a plant asset’s cost that is allocated to
that period.
54. All plant assets, including land, eventually wear out or decline in usefulness.
55. Net income for a period will be overstated if accrued salaries are not recorded at the end
of the accounting period.
56. Depreciation measures the decline in market value of an asset.
57. A company owes its employees $5,000 for the year ended December 31. It will pay
employees on January 6 for the previous two weeks’ salaries. The year-end adjusting on entry
on December 31 will include a debit to Salaries Expense and a credit to Cash.
58. A company purchased $6,000 worth of supplies in August and recorded the purchase in
the Supplies account. On August 31, the fiscal year-end, the supplies count equaled $3,200.
The adjusting entry would include a $2,800 debit to Supplies.
59. A company performs 20 days work on a 30-day contract before the end of the year. The
total contract is valued at $6,000 and payment is not due until the contract is fully completed.
The adjusting entry includes a $4,000 credit to unearned revenue.
60. A company entered into a 2-month contract for $50,000 on April 1. It earned $25,000 of
the contract services in April and billed the customer. The company should recognize the
revenue when it receives the customer’s check.
61. The adjusted trial balance must be prepared before the adjusting entries are made.
62. An unadjusted trial balance is a list of accounts and balances prepared before adjustments
are recorded.
63. Financial statements can be prepared directly from the information in the adjusted trial
balance.
64. Asset and liability balances are transferred from the adjusted trial balance to the income
statement.
65. Revenue and expense balances are transferred from the adjusted trial balance to the
income statement.
66. In preparing statements from the adjusted trial balance, the balance sheet must be prepared
first.
67. It is acceptable to record prepayment of expenses as debits to expense accounts.
68. It is acceptable to record cash received in advance of providing products or services to
revenue accounts.
69. The time period assumption assumes that an organization’s activities can be divided into
specific time periods including all of the following except:
A. Months.
B. Quarters.
C. Fiscal years.
D. Calendar years.
E. Days.
70. A broad principle that requires identifying the activities of a business with specific time
periods such as months, quarters, or years is the:
A. Operating cycle of a business.
B. Time period assumption.
C. Going-concern assumption.
D. Matching principle.
E. Accrual basis of accounting.
71. Interim financial statements refer to financial reports:
A. That cover less than one year, usually spanning one, three, or six-month periods.
B. That are prepared before any adjustments have been recorded.
C. That show the assets above the liabilities and the liabilities above the equity.
D. Where revenues are reported on the income statement when cash is received and expenses
are reported when cash is paid.
E. Where the adjustment process is used to assign revenues to the periods in which they are
earned and to match expenses with revenues.