Learning Questions and Answers for Financial Accounting, Lesson 4.1 – Mastery Level

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Read all the questions to begin, one at a time. Think about the ones you know as well as the ones you do not know. Then, immediately read the questions again but this time with the answers. Take your time. Make sure you understand each answer. Mark any cards that you want to see again for additional study.

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(1) - As a beginning step in its financial reporting process, Ace Company classifies its accounting information within accounts. What is an account? (2) - What are examples of accounts? (3) - What is a transaction? (4) - What are examples of transactions?

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(5) - What is transaction analysis? (6) - A company buys a building for $600,000 by signing a ten-year note payable. On that date, what accounts are changed by this transaction? (7) – A company buys supplies to use in its business for $400 in cash. What accounts are affected by this transaction? (8) – How many accounts are affected in a transaction?

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(9) – Why are there at least two accounts affected in every transaction? (10) – What is an accrued expense? (11) – What is the problem with recording an accrued expense? Let’s assume the employees working for a company earn $1,000 each day and are paid every ten days. How is that recorded? (12) – Assume, in (11), that Company A decides to record the accrued expense each day. Why would company officials make that decision?

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(13) – Assume, in (11), that Company B decides to record nothing until payment. Why would company officials make that decision? (14) – Assume, in (11), that Company A decides to record the $1,000 accrued expense each day. After three days, the company prepares financial statements. What recording does Company A make at that time? (15) – Assume, in (11), that Company B decides to record nothing until payment. After three days, the company prepares financial statements. What recording does Company B make?

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Now, look at each answer and see how you did in determining what goes up and what goes down in these common transactions. I know some of this might be new to you. Nevertheless, you can do this. You can learn how to do every single one of these questions. Just follow what is in the textbook and in your Guided Readings cards. These questions should provide valuable practice.

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(1) - As a beginning step in its financial reporting process, Ace Company classifies its accounting information within accounts. What is an account?

An account is an individual monetary balance that an organization monitors and then reports to decision makers. Depending on the account, the balance signifies one particular asset, liability, revenue, expense, or the like.

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(2) - What are examples of accounts?

Cash, rent expense, cost of goods sold, salary payable, inventory, contributed capital and the like are all accounts. Each of the individual balances reported on an income statement, statement of retained earnings, and balance sheet reflects an account. (The statement of cash flows is different because it looks at the composition of one account—cash.) During the year, every reporting company should keep up with each of those accounts in some way so that fairly presented financial statements can be prepared.

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(3) - What is a transaction?

A transaction is any financial event that causes a change in account balances.

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(4) - What are examples of transactions?

Table 4.1 of the textbook gives ten examples of common transactions. Look those over. Nevertheless, any company might literally experience hundreds of different transactions. For example, a company might buy a building for cash, pay for an advertisement in a newspaper, have damaged equipment fixed, borrow money, distribute a dividend, and more. In almost any organization, financial events happen constantly that change account balances.

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(5) - What is transaction analysis?

Transaction analysis is the examination of a transaction to determine its effect on account balances. More than any other single sentence, that is what a financial accountant does. Many transactions are simple to analyze but a significant number can be extremely complicated. “What happened here?” and “What are the ramifications of this event?” are two questions that financial accountants face often. They are questions that a financial accounting student should consider when looking at any transaction.

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(6) - A company buys a building for $600,000 by signing a ten-year note payable. On that date, what accounts are changed by this transaction?

The Building account increases $600,000 while the Note Payable account increases by the same amount.

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(7) – A company buys supplies to use in its business for $400 in cash. What accounts are affected by this transaction?

The Supplies account is a current asset. It is used to monitor items (such as paper and envelopes) that are used in a business and normally are consumed within one year. Here, the Supplies account goes up $400 and cash goes down $400.

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(8) – How many accounts are affected in a transaction?

In every transaction, at least two account balances are changed. There can be more than two but there must be at least two.

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(9) – Why are there at least two accounts affected in every transaction?

In every financial event (transaction), there has to be both a cause and an effect. No effect happens without a cause. Supplies went up because cash went down. Cash went up because sales revenue went up. There cannot be an effect without a cause so at least two accounts must be involved in every transaction.

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(10) – What is an accrued expense?

An accrued expense is one that grows gradually over time. A company can have many accrued expenses such as salary, rent, utilities, and interest. They do not happen in one distinct transaction. They occur gradually day by day.

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(11) – What is the problem with recording an accrued expense?

Let’s assume the employees working for a company earn $1,000 each day and are paid every ten days. How is that recorded? After the ten-day period, salary expense will have increased by $10,000 and cash will have decreased by $10,000. The end result is known. The problem is how to get there. Here are two possible ways. (A) The company increases salary expense $1,000 each day along with salary payable. At the end of ten days when payment is made, salary payable goes down $10,000 and cash goes down $10,000. That works perfectly. The recording reflects what happened. (B) The company does no recording for ten days. When payment is made, salary expense goes up $10,000 and cash goes down $10,000. That way also arrives at the proper end result and it is less work.

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(12) – Assume, in (11), that Company A decides to record the accrued expense each day. Why would company officials make that decision?

In this approach, during the ten days, the accounting records are always up-to-date. If company officials plan to use the account balances for internal decision making, they would naturally prefer that every balance be presented fairly. Furthermore, if financial statements are made during those ten days, the accounts are already up-to-date and can be used without any change.

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(13) – Assume, in (11), that Company B decides to record nothing until payment. Why would company officials make that decision?

Doing nothing for ten days is obviously easier and cheaper. If company officials are unlikely to make use of the account balances during those ten days, why go to the trouble? If financial statements need to be prepared during those days, adding in the expense and the liability is not that much of an additional problem.

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(14) – Assume, in (11), that Company A decides to record the $1,000 accrued expense each day. After three days, the company prepares financial statements. What recording does Company A make at that time?

Each day salary expense increases $1,000 and salary payable increases $1,000. After three days, when the financial statements are prepared, no changes need to be recorded because the balances are properly stated. After that, the company will continue to record $1,000 each day. When payment is eventually made, salary payable is reduced by $10,000 and cash is reduced by $10,000. The recording mirrors what transpires.

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(15) – Assume, in (11), that Company B decides to record nothing until payment. After three days, the company prepares financial statements. What recording does Company B make?

Nothing is recorded for the first three days. When the financial statements are prepared, the company owes its employees $3,000 for those first three days. In order for the financial statements to be prepared fairly on that date, salary expense is increased by $3,000 and salary payable is increased by $3,000. Nothing else is recorded for the next seven days. When payment is made, cash is reduced for $10,000 because that is the amount given to the employees. The $3,000 salary payable is decreased to remove it from the records. Salary expense is increased by $7,000 to recognize the expense for the seven days after the financial statements were made.

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I realize in (15) above that the handling is a bit tricky because of the insertion of the financial statements after three days. This accounting process is designed to make the daily work as easy as possible and record what is appropriate when the financial statements are prepared and then again when payment is made. Review this answer a few times and I believe you will see the pattern. Repetition and practice help a lot in accounting.

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Now, return to the questions at the beginning of this series. Read each question carefully and see if you can come up with the correct answer. You are forming a strong level of foundational knowledge. When a transaction occurs, what accounts are affected and how? If you can get a strong understanding of this process, the rest of the course will get easier.

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