CHAPTER 3: Adjusting the Accounts

The revenue recognition principle states that:

• revenue should be recognized in the accounting period in

  which a performance obligation is satisfied.

• expenses should be matched with revenues.

• the economic life of a business can be divided into artificial time periods.

• the fiscal year should correspond with the calendar year.

Answer explanation

Revenue should be recognized in the accounting period in which a performance obligation is satisfied. The other choices are incorrect because (b) defines the expense recognition principle, (c) describes the time period assumption, and (d) a company’s fiscal year does not need to correspond with the calendar year.

The time period assumption states that:

• companies must wait until the calendar year is completed to prepare financial statements.

• companies use the fiscal year to report financial information.

• the economic life of a business can be divided into artificial

  time periods.

• companies record information in the time period in which the events occur.

Answer explanation

The economic life of a business can be divided into artificial time periods. The other choices are incorrect because (a) companies report their activities on a more frequent basis and not necessarily based on a calendar year; (b) companies report financial information more frequently than annually, such as monthly or quarterly, in order to evaluate results of operations; and (d) describes accrual-basis accounting.

Which of the following statements about the accrual basis of accounting is false?

• Events that change a company’s financial statements are recorded in the periods in which the events occur.

• Revenue is recognized in the period in which services are performed.

• This basis is in accordance with International Financial Reporting Standards.

• Revenue is recorded only when cash is received, and expense is recorded only when cash is paid.

Answer explanation

Under the accrual basis of accounting, revenue is recognized when the performance obligation is satisfied, not when cash is received, and expense is recognized when incurred, not when cash is paid. The other choices are all true statements.

Theprincipleorassumptiondictatingthatefforts(expenses) should be recognized in the period in which a company consumes assets or incurs liabilities to generate revenue is the:

• expense recognition principle.

• cost assumption.

• time period assumption.

• revenue recognition principle.

Answer explanation

The expense recognition principle dictates that companies rec- ognize expense in the period in which they make efforts to generate revenue. The other choices are incorrect because (b) there is no cost assumption, but the historical cost principle states that assets should be recorded at their cost; (c) the time period assumption states that the economic life of a business can be divided into artificial time periods; and (d) the revenue recognition principle indicates that revenue should be recognized in the accounting period in which a performance obligation is satisfied.

Adjusting entries are made to ensure that:

• expenses are recognized in the period in which they are

  incurred.

• revenues are recorded in the period in which services are performed.

• statementoffinancialpositionandincomestatementaccounts have correct balances at the end of an accounting period.

• All the responses above are correct.

Answer explanation

Adjusting entries are made for the reasons noted in choices (a), (b), and (c). The other choices are true statements, but (d) is the better answer.

Each of the following is a major type (or category) of ad-justing entries except:

• prepaid expenses.

• accrued revenues.

• accrued expenses.

• recognized revenues.

Answer explanation

Unearned revenues, not recognized revenues, is one of the major categories of adjusting entries. The other choices all list one of the major categories of adjusting entries.

The trial balance shows Supplies €1,350 and Supplies Expense €0. If €600 of supplies are on hand at the end of the period, the adjusting entry is:

• Dr. Supplies 600

  Cr. Supplies Expense 600

• Dr. Supplies 750

  Cr. Supplies Expense

  750

• Dr. Supplies Expense 750 Cr. Supplies 750

• Dr. Supplies 600 Cr. Expense Supplies 600

Answer explanation

Debiting Supplies Expense for €750 and crediting Supplies for €750 (€1,350 – €600) will decrease Supplies and increase Supplies Expense. The other choices are incorrect because (a) will increase Supplies and decrease Supplies Expense and also for the wrong amounts, (b) will increase Supplies and decrease Supplies Expense, and (d) will cause Supplies to have an incorrect balance of €750 (€1,350 – €600) and Supplies Expense to have an incorrect balance of €600 (€0 + €600).

Adjustments for prepaid expenses:

• decrease assets and increase revenues.

• decrease expenses and increase assets.

• decrease assets and increase expenses.

• decrease revenues and increase assets.

Answer explanation

Adjustments for prepaid expenses decrease assets and increase expenses. The other choices are incorrect because an adjusting entry for prepaid expenses (a) increases expenses, not revenues; (b) in- creases, not decreases, expenses and decreases, not increases, assets; and (d) increases expenses, not decreases, revenues and decreases, not increases, assets.

Accumulated Depreciation is:

• a contra asset account.

• an expense account.

• an equity account.

• liability account.

Answer explanation

Accumulated Depreciation is a contra asset account; it is offset against an asset account on the statement of financial position. The other choices are incorrect because Accumulated Depreciation is not (b) an expense account nor located on the income statement, (c) an equity account, or (d) a liability account.

Rivera Shipping computes depreciation on delivery equipment at ¥1,000 (amounts in thousands) for the month of June. The adjusting entry to record this depreciation is as follows

• Dr. Depreciation Expense 1,000

  Cr. Accumulated Depreciation—

  Rivera Shipping 1,000

• Dr. Depreciation Expense 1,000

  Cr. Equipment 1,000

• Dr. Depreciation Expense 1,000

  Cr. Accumulated Depreciation—

  Equipment 1,000

• Dr. Equipment Expense 1,000

  Cr. Accumulated Depreciation—

  Equipment 1,000

Answer explanation

The adjusting entry is to debit Depreciation Expense and credit Accumulated Depreciation—Equipment. The other choices are incorrect because (a) the contra asset account title includes the asset being depreciated, not the company name; (b) the credit should be to the contra asset account, not directly to the asset; and (d) the debit for this entry should be Depreciation Expense, not Equipment Expense.