Accrual vs Cash-Basis Accounting

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Questions and Answers

What is Accrual Accounting?

Accounting that recognizes transactions when cash is received

Accounting that recognizes a transaction when it occurs, whether or not cash is received or disbursed (correct)

Accounting that only records cash transactions

Accounting based on cash management

What are Accruals?

Revenues earned or expenses incurred before cash has been exchanged

What are Adjusting Entries?

Journal entries made to measure the period's income accurately

What is Cash-Basis Accounting?

Accounting that records transactions when cash is received or paid Signup and view all the answers

What are Deferrals?

Cash received or paid before revenue has been earned or expenses have been incurred Signup and view all the answers

What is a Fiscal Year?

Any consecutive year Signup and view all the answers

What is the Matching Principle?

Recording expenses in the time period they were incurred to match them with revenues Signup and view all the answers

What does the Revenue Recognition Principle state?

Revenue should be recorded when it is earned by providing goods or services Signup and view all the answers

What are Accrued Expenses?

Expenses that have been incurred but not recorded Signup and view all the answers

What is Accumulated Depreciation?

A contra asset account representing total depreciation taken to date Signup and view all the answers

How do you calculate Book Value?

Cost - Accumulated Depreciation Signup and view all the answers

What is carrying value?

Asset's cost minus its accumulated depreciation Signup and view all the answers

What is a Contra Account?

An account linked to another account with an opposite normal balance Signup and view all the answers

What are Deferred Expenses?

Amounts that are assets because they represent items paid for but used later Signup and view all the answers

What is Deferred Revenue?

A liability created when cash is collected in advance of providing goods/services Signup and view all the answers

What is Depreciation?

Allocation of an asset's cost to expenses over its useful life Signup and view all the answers

What are Long-Term Assets?

Property, plant, equipment, and land lasting more than 2 years Signup and view all the answers

What is Net Value?

The amount found by subtracting the balance of a contra-account from its linked account Signup and view all the answers

What are Prepaid Expenses?

Expenses paid in advance of their use Signup and view all the answers

What is Salvage Value?

The estimated value of a long-term asset at the end of its useful life Signup and view all the answers

What is the Straight-Line Depreciation Method?

(Cost of the asset - Salvage value) / Useful life of the asset Signup and view all the answers

What is an Unadjusted Trial Balance?

A trial balance prepared at the end of the accounting period before adjustments Signup and view all the answers

What is Unearned Revenue?

A liability created when cash is collected in advance of providing goods/services Signup and view all the answers

What is an Adjusted Trial Balance?

A list of all accounts with their adjusted balance Signup and view all the answers

What are Closing Entries?

Journal entries prepared at the end of the accounting period to zero out revenue, expenses, and dividends Signup and view all the answers

What is a Permanent Account?

Accounts like assets, liabilities, common stock, and retained earnings that are not closed Signup and view all the answers

What is a Post-Closing Trial Balance?

A list of accounts and their balances after closing entries have been journalized Signup and view all the answers

What are Temporary Accounts?

Accounts like revenue, expenses, and dividends that are closed at the end of the accounting period Signup and view all the answers

What describes the type of adjusting entries?

Deferrals and accruals Signup and view all the answers

Unearned revenue is always a:

Liability Signup and view all the answers

Study Notes

Accrual Accounting

Recognizes business transactions when they occur, regardless of cash movement.
Key distinction from cash-basis accounting, which only records transactions on cash exchange.

Accruals

Represents revenues earned or expenses incurred prior to cash exchange, indicating timing differences in transactions.

Adjusting Entries

Essential journal entries at the end of accounting periods to accurately report income and adjust asset and liability accounts before financial statements are generated.

Cash-Basis Accounting

Records transactions only when cash is received or paid, potentially misleading the financial position if not supplemented with accruals.

Deferrals

Cash transactions that occur before related revenues are earned or expenses incurred, affecting the timing of income and expense recognition.

Fiscal Year

A consecutive 12-month period used for financial reporting, influencing the timing of expense recognition and revenue reports.

Matching Principle

States that expenses should be recorded in the same period as the revenues they help generate, ensuring accurate profit measurement.

Revenue Recognition Principle

Indicates that revenues should be recorded when earned by delivery of goods or services, establishing a basis for recognizing income.

Accrued Expenses

Expenses incurred but not yet recorded in accounts, requiring adjusting entries to accurately reflect liabilities.

Accumulated Depreciation

A contra asset account that shows the total depreciation expense taken to date against long-term assets.

Book Value

The difference between an asset's cost and its accumulated depreciation, reflecting its net value on the balance sheet.

Carrying Value

Calculated as an asset's cost minus its accumulated depreciation, important for financial analysis.

Contra Account

An account linked to another that has a balance opposite to that of its associated account, used to track adjustments (e.g., accumulated depreciation).

Deferred Expenses

Prepaid amounts that will benefit future periods, recorded as assets until consumed.

Deferred Revenue

A liability representing cash received for services or goods yet to be delivered, requiring careful tracking until earned.

Depreciation

The allocation of an asset's cost over its useful life, impacting expense recognition and asset valuation.

Long-Term Assets

Assets such as property, plant, and equipment that have a useful life exceeding two years, critical for capital investment assessments.

Net Value

The amount found by subtracting the balance of a contra account from the related account, useful for evaluating asset value.

Prepaid Expenses

Payments made for future expenses recorded as assets until the benefit is realized.

Salvage Value

The estimated residual value of a long-term asset at the end of its useful life, considered in depreciation calculations.

Straight-Line Depreciation Method

A common method for calculating depreciation; determined by subtracting salvage value from asset cost and dividing by useful life.

Unadjusted Trial Balance

A preliminary trial balance prepared before making adjusting entries, important for identifying discrepancies before finalizing accounts.

Unearned Revenue

A liability created from cash received before providing services or goods; crucial for managing cash flow and revenue recognition.

Adjusted Trial Balance

A comprehensive listing of all accounts and their balances after adjusting entries, serving as a foundation for financial statement preparation.

Closing Entries

Entries made at the end of the accounting period to reset temporary accounts to prepare for the next period.

Permanent Accounts

Accounts such as assets, liabilities, and equity that carry over into the next accounting period and are not closed.

Post-Closing Trial Balance

A final list of accounts and balances after closing entries, ensuring accuracy in ongoing reporting.

Temporary Accounts

Accounts like revenue, expenses, and dividends that are closed at the end of the period to reset for the next accounting cycle.

Types of Adjusting Entries

Two main types: deferrals (prepaid expenses and unearned revenue) and accruals (accrued expenses and revenues).

Importance of Adjusting Accounts

Updating accounts at the end of the accounting period is essential for accurate financial reporting and compliance.

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Description

This quiz explores the key concepts of accrual and cash-basis accounting, focusing on the timing of transactions and the impact on financial reporting. You will learn about accruals, adjusting entries, deferrals, and fiscal year considerations. Test your understanding of how these principles influence income and expense recognition.