Chapter 4 1 Explain the accrual basis of accounting and the reasons

Document Type
Test Prep
Book Title
Financial Accounting-- Binder Ready Version: Tools for Business Decision Making 8th Edition
Authors
Donald E. Kieso, Jerry J. Weygandt, Paul D. Kimmel
FOR INSTRUCTOR USE ONLY
CHAPTER 4
ACCRUAL ACCOUNTING CONCEPTS
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVE AND BLOOM’S TAXONOMY
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Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
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*This topic is dealt with in an Appendix to the chapter.
Accrual Accounting Concepts
FOR INSTRUCTOR USE ONLY
4-3
SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE
L.O. 1 L.O. 1 (cont.) L.O. 1 (cont.) L.O. 2 L.O. 2 (cont.)
Item Type Item Type Item Type Item Type Item Type
1. TF 77. MC 266. Ex 24. TF 153. MC
2. TF 78. MC 267. Ex 25. TF 154. MC
3. TF 79. MC 268. Ex 26. TF 155. MC
4. TF 80. MC 292. C 27. TF 156. MC
5. TF 81. MC 293. C 28. TF 157. MC
6. TF 82. MC 294. C 29. TF 158. MC
7. TF 83. MC 295. C 30. TF 159. MC
8. TF 84. MC 296. C 31. TF 160. MC
9. TF 85. MC 32. TF 161. MC
10. TF 86. MC 116. MC 162. MC
11. TF 87. MC 117. MC 163. MC
12. TF 88. MC 118. MC 164. MC
13. TF 89. MC 119. MC 165. MC
14. TF 90. MC 120. MC 166. MC
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22. TF 96. MC 126. MC 172. MC
23. TF 97. MC 126. MC 173. MC
54. MC 98. MC 127. MC 174. MC
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65. MC 110. MC 139. MC 269. Ex
66. MC 111. MC 140. MC 270. Ex
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69. MC 114. MC 143 MC 273. Ex
70. MC 115. MC 144. MC 274. Ex
71. MC 248. Be 145. MC 275. Ex
72. MC 249. Be 146. MC 276. Ex
73. MC 250. Be 147. MC 277. Ex
74. MC 252. Be 148. MC 278. Ex
75. MC 264. Ex 151. MC 279. Ex
76. MC 265. Ex 152. MC 280. Ex
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
FOR INSTRUCTOR USE ONLY
4-4
L.O. 2 (cont.) L.O. 3 (cont.) L.O. 4 L.O. 4 (cont.) L.O.*5
Item Type Item Type Item Type Item Type Item Type
281. Ex 197. MC 37. TF 235. MC 53. TF
282. Ex 198. MC 38. TF 236. MC 243. MC
283. Ex 199. MC 39. TF 237. MC 244. MC
284. Ex 200. MC 40. TF 238. MC 245. MC
285. Ex 201. MC 41. TF 239. MC 246. MC
288. Ex 202. MC 42. TF 240. MC 247. MC
289. Ex 203. MC 43. TF 241. MC
297. C 204. MC 44. TF 242. MC
298. C 205. MC 45. TF 261. Be
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251. Be 48. TF 290. Ex
253. Be 49. TF 291. Ex
257. Be 50. TF 300. C
258. Be 51. TF 301. C
260. Be 52. TF 302. C
269. Ex 208. MC
33. TF 271. Ex 210. MC
34. TF 272. Ex 211. MC
35. TF 273. Ex 212. MC
36. TF 274. Ex 213. MC
149. MC 277. Ex 214. MC
150. MC 278. Ex 215. MC
178. MC 279. Ex 216. MC
179. MC 280. Ex 217. MC
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187. MC 288. Ex 225. MC
188. MC 299. C 226. MC
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195. MC 233. MC
196. MC 234. MC
Note: TF = True-False C = Completion
MC = Multiple Choice Ex = Exercise
The chapter also contains one set of ten Matching questions and ten Short-Answer Essay questions.
Accrual Accounting Concepts
FOR INSTRUCTOR USE ONLY
4-5
CHAPTER LEARNING OBJECTIVES
1. Explain the accrual basis of accounting and the reasons for adjusting entries. The reve-
nue recognition principle dictates that companies recognize revenue when a performance
obligation has been satisfied. The expense recognition principle dictates that companies rec-
ognize expenses in the period when the company makes efforts to generate those revenues.
Under the cash basis, companies record events only in the periods in which the company re-
ceives or pays cash. Accrual-based accounting means that companies record in the periods in
which the events occur, events that change a company's financial statements even if cash has
not been exchanged.
Companies make adjusting entries at the end of an accounting period. These entries ensure
that companies record revenues in the period in which the performance obligation is satisfied
and that companies recognize expenses in the period in which they are incurred. The major
types of adjusting entries are prepaid expenses, unearned revenues, accrued revenues, and
accrued expenses.
2. Prepare adjusting entries for deferrals. Deferrals are either prepaid expenses or unearned
revenues. Companies make adjusting entries for deferrals at the statement date to record the
portion of the deferred item that represents the expense incurred or the revenue for services
performed in the current accounting period.
3. Prepare adjusting entries for accruals. Accruals are either accrued revenues or accrued
expenses. Adjusting entries for accruals record revenues earned and expenses incurred in the
current accounting period that have not been recognized through daily entries.
4. Prepare an adjusted trial balance and closing entries. An adjusted trial balance is a trial
balance that shows the balances of all accounts, including those that have been adjusted, at
the end of an accounting period. The purpose of an adjusted trial balance is to show the effects
of all financial events that have occurred during the accounting period.
One purpose of closing entries is to transfer net income or net loss for the period to Retained
Earnings. A second purpose is to “zero-out” all temporary accounts (revenue accounts, ex-
pense accounts, and Dividends) so that they start each new period with a zero balance. To
accomplish this, companies “close” all temporary accounts at the end of an accounting period.
They make separate entries to close revenues and expenses to Income Summary, Income
Summary to Retained Earnings, and Dividends to Retained Earnings. Only temporary accounts
are closed.
The required steps in the accounting cycle are (a) analyze business transactions, (b) journalize
the transactions, (c) post to ledger accounts, (d) prepare a trial balance, (e) journalize and post
adjusting entries, (f) prepare an adjusted trial balance, (g) prepare financial statements, (h)
journalize and post-closing entries, and (i) prepare a post-closing trial balance.
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
FOR INSTRUCTOR USE ONLY
4-6
*5.Describe the purpose and the basic form of a worksheet. The worksheet is a device to make
it easier to prepare adjusting entries and the financial statements. Companies often prepare a
worksheet using a computer spreadsheet. The sets of columns of the worksheet are, from left
to right, the unadjusted trial balance, adjustments, adjusted trial balance, income statement,
and balance sheet.
Accrual Accounting Concepts
4-7
TRUE-FALSE STATEMENTS
1. The periodicity assumption states that the economic life of a business entity can be divided
into artificial time periods.
2. The periodicity assumption is often referred to as the expense recognition principle.
3. The revenue recognition principle dictates that revenue be recognized in the accounting pe-
riod in which the performance obligation is satisfied.
4. Expense recognition is tied to revenue recognition.
5. The revenue recognition principle and the expense recognition principle are helpful guides
used in determining net income or net loss for a period.
6. The expense recognition principle requires that efforts be related to accomplishments.
7. Recognizing when an expense contributes to the production of revenue is critical.
8. The expense recognition principle is frequently referred to as the matching principle.
9. Income will always be greater under the cash basis of accounting than under the accrual ba-
sis of accounting.
10. The cash basis of accounting is not in accordance with generally accepted accounting princi-
ples.
11. Adjusting entries are often made because some business events are not recorded as they
occur.
12. Adjusting entries are recorded in the general journal but are not posted to the accounts in the
general ledger.
13. Adjusting entries are not necessary if the trial balance debit and credit columns balances are
equal.
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
4-8
14. An adjusting entry would be made to the revenue account only when cash is received.
15. An adjusting entry to a prepaid expense is required to recognize expired expenses.
16. An adjusting entry always involves two balance sheet accounts.
17. An adjusting entry always involves a balance sheet account and an income statement ac-
count.
18. Revenue received before it is recognized and expenses paid before being used or consumed
are both initially recorded as liabilities.
19. Revenue received before it is recognized and expenses used or consumed before being paid
are both initially recorded as liabilities.
20. Accrued revenues are revenues that have been received but not yet recognized.
21. Accrued revenues are revenues that have been recognized but not yet recorded.
22. The difference between unearned revenue and accrued revenue is that accrued revenue has
been recorded and needs adjusting and unearned revenue has never been recorded.
23. If prepaid costs are initially recorded as an asset, no adjusting entries will be required in the
future.
24. The cost of a depreciable asset less accumulated depreciation reflects the book value of the
asset.
25. The book value of a depreciable asset is always equal to its market value because deprecia-
tion is a valuation technique.
26. Accumulated Depreciation is a liability account and has a credit normal account balance.
27. A liabilityrevenue account relationship exists with an unearned rent revenue adjusting en-
try.
Accrual Accounting Concepts
4-9
28. The balances of the Depreciation Expense and the Accumulated Depreciation accounts
should always be the same.
29. Unearned revenue is a prepayment that requires an adjusting entry when services are per-
formed.
30. The adjusting entry for unearned revenue results in an increase (a debit) to an asset account
and an increase (a credit) to a revenue account.
31. Asset prepayments become expenses when they expire.
32. A contra asset account is subtracted from a related account in the balance sheet.
33. Accrued revenues are revenues that have been recognized but cash has not been received
before financial statements have been prepared.
34. The adjusting entry for accrued salaries requires a debit to Salaries and Wages Payable.
35. The accrued interest for a three month note payable of $10,000 dated December 1, 2017 at
an interest rate of 6% is $150 on December 31, 2017.
36. Without an adjusting entry for accrued interest expense, liabilities and interest expense are
understated, and net income and stockholders’ equity are overstated.
37. Financial statements can be prepared from the information provided by an adjusted trial bal-
ance.
38. An adjusted trial balance must be prepared before the adjusting entries can be recorded.
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
4-10
39. Closing entries deal primarily with the balances of permanent accounts.
40. The only accounts that are closed are temporary accounts.
41. When closing entries are prepared, each income statement account is closed directly to re-
tained earnings.
42. Cash is a temporary account.
43. The post-closing trial balance will contain only permanentbalance sheetaccounts.
44. Accounts receivable is a permanent account.
45. The Dividends account is closed to the Income Summary account at the end of each year.
46. A revenue account is closed with a credit to the revenue account and a debit to Income
Summary.
47. An expense account is closed with a credit to the expense account and a debit to the Income
Summary account.
48. Financial statements must be prepared before the closing entries are made.
49. In the accounting cycle, closing entries are prepared before adjusting entries.
50. Closing entries result in the transfer of net income or net loss into the Retained Earnings ac-
count.
51. The post closing trial balance will have fewer accounts than the adjusted trial balance.
Accrual Accounting Concepts
FOR INSTRUCTOR USE ONLY
4-11
52. The accounting cycle begins with the journalizing of the transactions.
*53. A 10-column worksheet is a permanent accounting record.
Answers to True-False Statements
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
4-12
MULTIPLE CHOICE QUESTIONS
54. The periodicity assumption states that:
a. a transaction can only affect one period of time.
b. estimates should not be made if a transaction affects more than one time period.
c. adjustments to the enterprise's accounts can only be made in the time period when the
business terminates its operations.
d. the economic life of a business can be divided into artificial time periods.
55. One of the accounting concepts upon which adjustments for prepayments and accruals are
based is:
a. expense recognition.
b. cost.
c. monetary unit.
d. economic entity.
56. An accounting time period that is one year in length is called:
a. a fiscal year.
b. an interim period.
c. the time period assumption.
d. a reporting period.
57. Adjustments would not be necessary if financial statements were prepared to reflect net in-
come from:
a. monthly operations.
b. fiscal year operations.
c. interim operations.
d. lifetime operations.
58. Management usually wants ________ financial statements and the IRS requires all busi-
nesses to file _________ tax returns.
a. annual, annual
b. monthly, annual
c. quarterly, monthly
d. monthly, monthly
Accrual Accounting Concepts
4-13
59. Expenses are recognized when:
a. they contribute to the production of revenue.
b. they are paid.
c. they are billed by the supplier.
d. the invoice is received.
60. Which of the following is not generally an accounting time period?
a. A week.
b. A month.
c. A quarter.
d. A year.
61. The revenue recognition principle dictates that revenue should be recognized in the account-
ing records:
a. when cash is received.
b. when the performance obligation is satisfied.
c. at the end of the month.
d. in the period that income taxes are paid.
62. In a service-type business, revenue is recognized:
a. at the end of the month.
b. at the end of the year.
c. when the service is performed.
d. when cash is received.
63. The expense recognition principle matches:
a. customers with businesses.
b. expenses with revenues.
c. assets with liabilities.
d. creditors with businesses.
64. Otto’s Tune-Up Shop follows the revenue recognition principle. Otto services a car on August
31. The customer picks up the vehicle on September 1 and mails the payment to Otto on
September 5. Otto receives the check in the mail on September 6. When should Otto show
that the revenue was recognized?
a. August 31
b. August 1
c. September 5
d. September 6
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
4-14
65. A company spends $20 million dollars for an office building. Over what period should the cost
be written off?
a. When the $20 million is expended in cash.
b. All in the first year.
c. After $20 million in revenue is earned.
d. None of these answer choices are correct.
66. The expense recognition principle states that expenses should be matched with revenues.
Another way of stating the principle is to say that:
a. assets should be matched with liabilities.
b. efforts should be matched with accomplishments.
c. dividends should be matched with stockholder investments.
d. cash payments should be matched with cash receipts.
67. Which principle dictates that efforts (expenses) be recorded with accomplishments (reve-
nues)?
a. Historical cost principle.
b. Periodicity principle.
c. Revenue recognition principle.
d. Expense recognition principle.
68. A flower shop makes a large sale for $1,000 on November 30. The customer is sent a state-
ment on December 5 and a check is received on December 10. The flower shop follows
GAAP and applies the revenue recognition principle. When is the $1,000 considered to be
recognized?
a. December 5
b. December 10
c. November 30
d. December 1
69. A furniture factory's employees work overtime to finish an order that is sold on January 31.
The office sends a statement to the customer in early February and payment is received by
mid-February. The overtime wages should be expensed in:
a. January.
b. February.
c. the period when the workers receive their checks.
d. either January or February depending on when the pay period ends.
Accrual Accounting Concepts
4-15
70. Which is not an application of revenue recognition?
a. Recording revenue as an adjusting entry on the last day of the accounting period.
b. Accepting cash from an established customer for services to be performed over the next
three months.
c. Billing customers on June 30 for services completed during June.
d. Receiving cash for services performed.
71. Why do generally accepted accounting principles require the application of the revenue
recognition principle?
a. Failure to apply the revenue recognition principle could lead to a misstatement of reve-
nue.
b. It is easy to apply the revenue recognition principle because revenue issues are always
easy to identify and resolve.
c. Recording revenue when cash is received is an objective application of the revenue
recognition principle.
d. Accounting software has made the revenue recognition easy to apply.
72. On April 1, 2017, nPropel Corporation paid $48,000 cash for equipment that will be used in
business operations. The equipment will be used for four years. nPropel records depreciation
expense of $48,000 for the calendar year ending December 31, 2017. Which accounting
principle has been violated?
a. Depreciation principle.
b. No principle has been violated.
c. Cash principle.
d. Expense recognition principle.
73. Under the cash basis of accounting:
a. revenue is recognized when services are performed.
b. expenses are matched with the revenue that is produced.
c. cash must be received before revenue is recognized.
d. a promise to pay is sufficient to recognize revenue.
74. Under the accrual basis of accounting:
a. cash must be received before revenue is recognized.
b. net income is calculated by matching cash outflows against cash inflows.
c. events that change a company's financial statements are recognized in the period they
occur rather than in the period in which cash is paid or received.
d. the ledger accounts must be adjusted to reflect a cash basis of accounting before finan-
cial statements are prepared under generally accepted accounting principles.
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
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75. Using accrual accounting, expenses are recorded and reported only:
a. when they are incurred whether or not cash is paid.
b. when they are incurred and paid at the same time.
c. if they are paid before they are incurred.
d. if they are paid after they are incurred.
76. A small company may be able to justify using a cash basis of accounting if they have:
a. sales under $1,000,000.
b. no accountants on staff.
c. few receivables and payables.
d. all sales and purchases on account.
77. Which statement is correct?
a. As long as a company consistently uses the cash basis of accounting, generally accepted
accounting principles allow its use.
b. The use of the cash basis of accounting violates both the revenue recognition and ex-
pense recognition principles.
c. The cash basis of accounting is objective because no one can be certain of the amount
of revenue until the cash is received.
d. As long as management is ethical, there are no problems with using the cash basis of
accounting.
78. The following is selected information from L Corporation for the fiscal year ending October
31, 2017.
Cash received from customers
$300,000
Revenue recognized
440,000
Cash paid for expenses
170,000
Cash paid for computers on November 1, 2016 that will
be used for 3 years
48,000
Expenses incurred including any depreciation
216,000
Proceeds from a bank loan, part of which was used to
pay for the computers
100,000
Based on the accrual basis of accounting, what is L Corporation’s net income for the year
ending October 31, 2017?
a. $254,000
b. $224,000
c. $208,000
d. $270,000
Accrual Accounting Concepts
4-17
79. The following is selected information from C Corporation for the fiscal year ending October
31, 2017.
Cash received from customers
$150,000
Revenue recognized
225,000
Cash paid for expenses
85,000
Cash paid for computers on November 1, 2016 that
will be used for 3 years
24,000
Expenses incurred including any depreciation
119,000
Proceeds from a bank loan, part of which was used to
pay for the computers
50,000
Based on the accrual basis of accounting, what is C Corporation’s net income for the year
ending October 31, 2017?
a. $132,000
b. $116,000
c. $106,000
d. $140,000
80. La More Company had the following transactions during 2016:
Sales of $9,000 on account
Collected $4,000 for services to be performed in 2017
Paid $3,750 cash in salaries for 2016
Purchased airline tickets for $500 in December for a trip to take place in 2017
What is La More’s 2016 net income using accrual accounting?
a. $5,750
b. $9,750
c. $9,250
d. $5,250
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
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81. La More Company had the following transactions during 2016.
Sales of $9,000 on account
Collected $4,000 for services to be performed in 2017
Paid $2,650 cash in salaries
Purchased airline tickets for $500 in December for a trip to take place in 2017
What is La More’s 2016 net income using cash basis accounting?
a. $10,350
b. $1,350
c. $9,850
d. $850
82. Wang Company had the following transactions during 2016:
Sales of $10,800 on account
Collected $4,800 for services to be performed in 2017
Paid $2,600 cash in salaries for 2016
Purchased airline tickets for $600 in December for a trip to take place in 2017
What is Wang’s 2016 net income using accrual accounting?
a. $8,800
b. $13,600
c. $13,000
d. $8,200
83. Wang Company had the following transactions during 2016:
Sales of $10,800 on account
Collected $4,800 for services to be performed in 2017
Paid $2,600 cash in salaries
Purchased airline tickets for $600 in December for a trip to take place in 2017
What is Wang’s 2016 net income using cash basis accounting?
a. $1,600
b. $2,800
c. $13,000
d. $2,200
Accrual Accounting Concepts
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84. Given the data below for a firm in its first year of operation, determine net income under the
cash basis of accounting.
Revenue recognized $19,000
Accounts receivable 3,000
Expenses incurred 7,250
Accounts payable (related to expenses) 750
Supplies purchased with cash 1,800
a. $9,500
b. $14,000
c. $7,700
d. $9,950
85. Given the data below for a firm in its first year of operation, determine net income under the
accrual basis of accounting.
Revenue recognized $19,000
Accounts receivable 3,000
Expenses incurred 7,250
Accounts payable (related to expenses) 750
Supplies purchased with cash 1,800
a. $11,750
b. $14,000
c. $9,500
d. $12,200
86. Given the data below for a firm in its first year of operation, determine net income under the
cash basis of accounting.
Cash received from customers $45,000
Accounts receivable 12,000
Cash paid for expenses 26,000
Accounts payable (related to expenses) 3,000
Prepaid rent for next period 7,000
a. $19,000
b. $28,000
c. $21,000
d. $12,000
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
4-20
87. Given the data below for a firm in its first year of operation, determine net income under the
accrual basis of accounting.
Cash received from customers $45,000
Accounts receivable 12,000
Cash paid for expenses 26,000
Accounts payable (related to expenses) 3,000
Prepaid rent for next period 7,000
a. $19,000
b. $28,000
c. $21,000
d. $12,000
88. Under the cash basis of accounting, an amount received from a customer in advance of
providing the services would be reported as a(n):
a. revenue.
b. liability.
c. expense.
d. prepaid expense.
89. Which of the following would not be an application of the revenue recognition or expense
recognition principle?
a. Recording accrued salaries and wages expense.
b. Recording accrued interest revenue.
c. Recording the collection of an advance customer payment as revenue.
d. Recording prepaid expense adjustments.
90. Why was Apple required to spread their iPhone revenues over a two year period?
a. Because of its newness, their returns might exceed the normal level of returns.
b. Because they were required to provide software updates over that two year period.
c. Because that was the estimated life of the iPhone.
d. Because they needed to defer revenue recognition since they had a swap program avail-
able for future models.
91. Which of the following is an example of a deferral adjusting entry?
a. Accrued expense
b. Accrued revenue
c. Prepaid expense
d. All of these choices are correct.

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