Financial Reporting Operations Flashcards

Question 1

What are the four primary financial statements that most companies prepare?

Accepted Answer

The four primary financial statements are the income statement, balance sheet, statement of cash flows, and statement of changes in equity. The income statement reports revenues and expenses over a period, while the balance sheet shows assets, liabilities, and equity at one point in time.

Question 2

What does the accounting equation state, and why must it always hold?

Accepted Answer

The accounting equation states that assets equal liabilities plus equity. It must always hold because every transaction affects at least two accounts, so each recorded change keeps both sides balanced. Double-entry bookkeeping enforces this rule, which is why a trial balance can reveal some recording errors.

Question 3

What is the difference between accrual accounting and cash basis accounting?

Accepted Answer

Accrual accounting records revenues when they are earned and expenses when they are incurred, regardless of when cash changes hands. Cash basis accounting records transactions only when cash is received or paid. Accrual accounting gives a fuller picture of performance in a period, and most public companies use it.

Question 4

What is the matching principle, and how does it shape expense recognition?

Accepted Answer

The matching principle requires that expenses be recorded in the same period as the revenues they helped produce. For example, the cost of goods sold belongs in the period when the related products are sold, not when they were bought. This principle drives adjusting entries such as depreciation.

Question 5

What is a general ledger, and how does it relate to the journal?

Accepted Answer

A general ledger is the complete set of accounts a business uses to summarize its transactions, with each account showing its balance. Transactions are first recorded in the journal in chronological order, then posted to the matching ledger accounts. Posting moves each debit and credit from the journal into the ledger.

Question 6

What is the purpose of a trial balance?

Accepted Answer

A trial balance is a list of all ledger account balances at a point in time, arranged in debit and credit columns. Its main purpose is to confirm that total debits equal total credits, which is a basic check on the arithmetic of the bookkeeping.

Question 7

What is a journal entry, and what must each entry include?

Accepted Answer

A journal entry is the first formal record of a business transaction, showing which accounts change and by how much. Each entry must include the date, the accounts affected, the debit and credit amounts, and a short description. Total debits must equal total credits in every entry.

Question 8

What is the normal balance of asset, liability, equity, revenue, and expense accounts?

Accepted Answer

Asset and expense accounts normally carry debit balances, which means debits increase them. Liability, equity, and revenue accounts normally carry credit balances, so credits increase them. A debit decreases a liability, equity, or revenue account, and a credit decreases an asset or expense account.

Question 9

What are the main steps of the accounting cycle, in order?

Accepted Answer

The accounting cycle begins with identifying and analyzing transactions, then journalizing them, posting to the ledger, and preparing an unadjusted trial balance. Next come adjusting entries, an adjusted trial balance, financial statements, closing entries, and a post-closing trial balance. Each step builds on the one before, so errors early in the cycle carry forward.

Question 10

Why are adjusting entries needed at the end of a period?

Accepted Answer

Adjusting entries are needed because some revenues and expenses occur over time and are not captured by ordinary daily transactions. Without them, the statements would omit earned revenue, unpaid expenses, or the use of prepaid items and long-lived assets. Common examples include accrued wages, accrued revenue, prepaid rent, and depreciation.

Question 11

What is the difference between accrued revenue and deferred revenue?

Accepted Answer

Accrued revenue is revenue the company has earned by delivering goods or services but has not yet billed or received cash for. Deferred revenue is cash received before the company has earned it, so it is recorded as a liability. When the work is performed, deferred revenue moves into earned revenue.

Question 12

What is a closing entry, and which accounts does it affect?

Accepted Answer

A closing entry moves the balances of temporary accounts, such as revenues, expenses, and dividends or withdrawals, into retained earnings or owner's capital. This resets the temporary accounts to zero so they start the next period fresh. Permanent accounts, such as assets, liabilities, and common stock, are not closed because their balances carry forward.

Question 13

What is the purpose of reversing entries, and when are they used?

Accepted Answer

Reversing entries are optional entries made on the first day of a new period that cancel certain accrual adjustments from the prior period. They simplify bookkeeping, because the regular entry recorded when cash is later received or paid can be recorded as usual without special handling.

Question 14

Why does a post-closing trial balance include only permanent accounts?

Accepted Answer

A post-closing trial balance includes only permanent accounts because temporary accounts have been reset to zero by the closing entries. Because it is prepared after closing, it checks that the closing process did not disturb balances in assets, liabilities, and equity.

Question 15

How does an accrued expense differ from an accounts payable balance?

Accepted Answer

An accrued expense is a cost incurred in the period but not yet billed or paid, so the company records it with an adjusting entry and a liability such as accrued wages payable. An accounts payable balance arises from a vendor invoice that has been received and recorded through normal purchasing.

Question 16

What is a prepaid expense, and how is it adjusted?

Accepted Answer

A prepaid expense is a payment made in advance for a benefit the company will receive later, such as insurance or rent, and it is initially recorded as an asset. As the benefit is used up over time, an adjusting entry debits expense and credits the prepaid asset. Prepaid insurance then becomes monthly expense.

Question 17

What are the five steps in the revenue recognition model?

Accepted Answer

The five steps are identify the contract with a customer, identify the separate performance obligations in it, determine the transaction price, allocate that price to each performance obligation, and recognize revenue when each obligation is satisfied. This model applies to most contracts with customers.

Question 18

How does allowance for doubtful accounts work?

Accepted Answer

The allowance for doubtful accounts is a contra asset account that estimates the portion of accounts receivable the company does not expect to collect. It reduces net receivables on the balance sheet, so the reported value reflects expected cash collection.

Question 19

What is the difference between bad debt expense under the allowance method and the direct write-off method?

Accepted Answer

The allowance method estimates bad debt expense in the same period as the related sales, which better matches expenses with revenue. The direct write-off method records the expense only when a specific account is judged uncollectible, which can leave revenue and expense in different periods. Public companies generally use the allowance method.

Question 20

How is a bank reconciliation used to check cash?

Accepted Answer

A bank reconciliation compares the cash balance in the company's books with the balance on the bank statement and explains every difference. Common reconciling items include deposits in transit, outstanding checks, bank fees, and interest earned. Adjustments on each side must bring both figures to the same true cash balance.

Question 21

What is the purpose of an aging schedule for receivables?

Accepted Answer

An aging schedule groups outstanding customer balances by how long each has been unpaid, such as current, past due by a month, or past due by several months. It helps management judge which balances are at risk and supports the estimate of the allowance for doubtful accounts.

Question 22

What does a sales return or sales allowance do to reported revenue?

Accepted Answer

A sales return or sales allowance reduces reported net revenue because part of the original sale is reversed or reduced. Companies usually record these amounts in a contra revenue account, so the gross sales figure stays visible. Where returns are expected, an estimated refund liability and a returns asset may also be recognized.

Question 23

What does days sales outstanding measure, and why do managers track it?

Accepted Answer

Days sales outstanding estimates the average number of days it takes to collect payment after a credit sale, calculated from receivables and credit sales over a period. A rising figure can signal slower customer payments, looser credit terms, or a higher risk of bad debts. Managers track it to judge collection efficiency.

Question 24

How does a company record a sale on credit?

Accepted Answer

A credit sale is recorded by debiting accounts receivable and crediting sales revenue for the amount the customer owes, once control transfers. If sales tax applies, the tax is credited to a liability account. When the customer pays, cash is debited and accounts receivable is credited, so no revenue is recorded at collection.

Question 25

How is depreciation recorded, and why is it not a cash expense?

Accepted Answer

Depreciation is recorded by debiting depreciation expense and crediting accumulated depreciation, a contra asset account. It is not a cash expense because no cash leaves the business when the entry is made; the cash was spent when the asset was bought. The entry spreads the asset's cost across the periods it helps generate revenue.

Question 26

What is the difference between a capital expenditure and a repair expense?

Accepted Answer

A capital expenditure adds value or extends the useful life of an asset, so its cost is recorded as an asset and depreciated over time. A repair expense only maintains the asset in its existing condition, so its cost is recognized immediately as an expense.

Question 27

How is inventory valued under the lower of cost and net realizable value rule?

Accepted Answer

Under the lower of cost and net realizable value rule, inventory is carried at the smaller of its cost or the estimated selling price less costs to complete and sell it. If the net realizable value falls below cost, the company writes inventory down and recognizes a loss in the period the decline occurs. This keeps assets from being reported above the amount expected to be recovered.

Question 28

What is the difference between FIFO and LIFO inventory costing?

Accepted Answer

FIFO assumes the oldest units are sold first, so ending inventory reflects the most recent purchase costs. LIFO assumes the newest units are sold first, so ending inventory reflects older costs. When prices are rising, FIFO usually produces higher reported income and LIFO produces a lower taxable result.

Question 29

What is the difference between a current liability and a long-term liability?

Accepted Answer

A current liability is an obligation due within one year or the normal operating cycle, whichever is longer. A long-term liability is due after that window, such as a mortgage or bonds payable with later maturities. Classification matters because it affects working capital and how lenders and investors judge short-term liquidity.

Question 30

What happens to bond premium or discount over the life of a bond?

Accepted Answer

A bond discount or premium is amortized over the bond's life, so interest expense reflects the market rate at issuance rather than only the cash coupon. A discount increases interest expense over time, while a premium decreases it. The unamortized balance is presented as a reduction or addition to the bonds payable carrying amount.

Question 31

What is an impairment, and when should a company test long-lived assets for it?

Accepted Answer

An impairment is a drop in an asset's recoverable value below its carrying amount. Companies test long-lived assets when events, such as a sharp market price drop or a decision to abandon the asset, suggest the carrying amount may not be recoverable. If impaired, the asset is written down and a loss is recognized.

Question 32

How are lease liabilities and right-of-use assets recognized for a long-term lease?

Accepted Answer

A lessee records most leases on the balance sheet as a right-of-use asset and a lease liability equal to the present value of remaining lease payments. The liability is reduced as payments are made and accrues interest, while the asset is amortized over the lease term. Short-term leases, generally twelve months or less, may be exempted from balance sheet recognition by election.

Question 33

What is the purpose of the period-end close?

Accepted Answer

The period-end close is the process of completing the accounting cycle for a reporting period so that financial statements are accurate and complete. It includes recording accruals, reconciling accounts, reviewing estimates, and locking the period against further changes. A disciplined close lets management and outside parties rely on the reported results.

Question 34

What is segregation of duties, and why does it matter in financial reporting?

Accepted Answer

Segregation of duties separates responsibilities such as recording transactions, approving them, and safeguarding assets, so that no single person controls an entire process. It matters because it reduces the chance of undetected errors and fraud. For example, the person who prepares a payment should not also approve it.

Question 35

What is the difference between a subsidiary ledger and the general ledger?

Accepted Answer

A subsidiary ledger holds detailed records for one category, such as individual customer accounts or vendor balances, while the general ledger holds summary totals for each control account. The subsidiary ledger total must agree with the matching control account in the general ledger. This comparison is a routine control.

Question 36

Why do companies use a standard month-end checklist?

Accepted Answer

A standard month-end checklist lists every recurring task, such as accruals, reconciliations, depreciation, and review sign-offs, with an owner and deadline for each. It makes the close repeatable, so tasks are not skipped when staff change or workloads rise. The completed checklist also serves as evidence that controls were performed.

Question 37

What is a material misstatement, and how does materiality affect close decisions?

Accepted Answer

A material misstatement is an error or omission large enough that it could influence the decisions of a reasonable user of the financial statements. Materiality is a judgment that considers both the size of an item and its nature, such as whether it changes a trend or turns a loss into a profit.

Question 38

How do analytical procedures help detect errors at period end?

Accepted Answer

Analytical procedures compare current results with prior periods, budgets, and expected relationships, such as gross margin or days sales outstanding, to spot unusual changes. A large or unexpected variance prompts investigation, which may reveal a posting error, a cutoff problem, or a missed accrual. Analytical review does not replace detailed testing.

Question 39

What is cutoff, and why does it matter at period end?

Accepted Answer

Cutoff means recording transactions in the period in which they actually occurred, so that sales and purchases near the boundary are neither pulled forward nor pushed back. Errors often appear with shipments, invoices, or deliveries dated close to period end. Correct cutoff keeps revenue, expenses, assets, and liabilities aligned with the correct reporting period.

Question 40

What is a subsequent event, and how does it affect period-end reporting?

Accepted Answer

A subsequent event is an event occurring after the balance sheet date but before the statements are issued. Recognized subsequent events provide evidence about conditions that existed at the balance sheet date, so amounts are adjusted. Nonrecognized events arose after that date, so they are disclosed when material rather than recorded in the statements.

Financial Reporting Operations Flashcards

1Foundations of double-entry recording

2Accounting cycle and adjustments

3Revenue recognition and receivables

4Asset and liability measurement

5Period-end close and controls

Learning Resources