ACCOUNTING PRINCIPLES INTERVIEW QUESTIONS & ANSWERS

Accounting principles are the rules and principles that business organizations have
to adopt to report their financial data. These are handled by the accountants where
they enumerate and execute the details of the organizations transactions. Various
leading organizations are having the job requirement for principle accountant
jobs which provide wide extension for the candidate’s future growth. So,
candidates who want to build a career in this need to know the recruitment criteria
and the process of interview where most of the jobseekers are unable to cope up
with. In order to increase the confident levels and self esteem, we have come up
with some of the Accounting principle interview questions and answers that are
commonly asked by top recruiters. Follow these questions before facing
the interview.

1. Question 1. What Is The Difference Between The Cash Basis And The
Accrual Basis Of Accounting?
Answer :
Under the cash basis of accounting...
o Revenues are reported on the income statement in the period in which
the cash is received from customers.
o Expenses are reported on the income statement when the cash is paid
out.
Under the accrual basis of accounting...
o Revenues are reported on the income statement when they are earned—
which often occurs before the cash is received from the customers.
o Expenses are reported on the income statement in the period when they
occur or when they expire—which is often in a period different from
when the payment is made.
The accrual basis of accounting provides a better picture of a company's profits
during an accounting period. The reason is that the income statement prepared
under the accrual basis will report all of the revenues actually earned during the
period and all of the expenses incurred in order to earn the revenues.
The accrual basis of accounting also provides a better picture of a company's
financial position at a moment or point in time. The reason is that all assets that
were earned are reported and all liabilities that were incurred will be reported.
The accrual basis of accounting is required because of the matching principle.
Question 2. What Is The Accrual Basis Of Accounting?
Answer :
Under the accrual basis of accounting, revenues are reported on the income
statement when they are earned. (Under the cash basis of accounting, revenues
are reported on the income statement when the cash is received.) Under the
accrual basis of accounting, expenses are matched with the related revenues
and/or are reported when the expense occurs, not when the cash is paid. The
result of accrual accounting is an income statement that better measures the
profitability of a company during a specific time period.
For example, if I begin an accounting service in December and provide $10,000
of accounting services in December, but don't receive any of the money from the
clients until January, there will be a difference in the income statements for
December and January under the accrual and cash bases of accounting. Under
the accrual basis, my income statements will show $10,000 of revenues in
December and none of those services will be reported as revenues in January.
Under the cash basis, my December income statement will show no revenues.
Instead, the December services will be reported as January revenues under the
cash method.
There will be a difference on the balance sheet, too. Under the accrual basis, the
December balance sheet will report accounts receivable of $10,000 and the
estimated true profit will be added to owner's equity or retained earnings. Under
the cash basis, the $10,000 of accounts receivable will not be reported as an
asset, and the true profit will not be included in owner's equity or retained
earnings.
To illustrate a difference in expenses, we will assume that the heat and light
expense that I used in my accounting service is metered by the utility on the last
day of the month. The utilities that I used in December will appear on a bill that
I receive in January and will pay on February 1. Under the accrual basis of
accounting, the utilities that I used in December will be estimated and will be
reported as an expense and a liability on the December financial statements.
Under the cash basis of accounting, the utilities used in December will be
recorded as an expense on February 1, when the utility bills are paid.
For financial statements prepared in accordance with generally accepted
accounting principles, the accrual method is required because of the matching
principle.
Question 3. What Are Accruals?
Answer :
Accruals are adjustments for 1) revenues that have been earned but are not yet
recorded in the accounts, and 2) expenses that have been incurred but are not yet
recorded in the accounts. The accruals need to be added via adjusting entries so
that the financial statements report these amounts.
An example of an accrual for revenue involves your electric utility company.
The utility used coal and many employees in December to generate electricity
that customers received in December. However, the utility doesn't bill the
electric customers for the December electricity until the meters are read in
January. To have the proper amounts on the utility's financial statements, there
needs to be an adjusting entry to increase revenues that were earned in
December and the receivables that the utility has a right to as of December 31.
Question 4. What Is A Capital Expenditure Versus A Revenue
Expenditure?
Answer :
A capital expenditure is an amount spent to acquire or improve a long-term asset
such as equipment or buildings. Usually the cost is recorded in an account
classified as Property, Plant and Equipment. The cost (except for the cost of
land) will then be charged to depreciation expense over the useful life of the
asset.
A revenue expenditure is an amount that is expensed immediately—thereby
being matched with revenues of the current accounting period. Routine repairs
are revenue expenditures because they are charged directly to an account such as
Repairs and Maintenance Expense. Even significant repairs that do not extend
the life of the asset or do not improve the asset (the repairs merely return the
asset back to its previous condition) are revenue expenditures.
Question 5. What Is A Contingent Liability?
Answer :
A contingent liability is a potential liability...it depends on a future event
occurring or not occurring. For example, if a parent guarantees a daughter's first
car loan, the parent has a contingent liability. If the daughter makes her car
payments and pays off the loan, the parent will have no liability. If the daughter
fails to make the payments, the parent will have a liability.
If a company is sued by a former employee for $500,000 for age discrimination,
the company has a contingent liability. If the company is found guilty, it will
have a liability. However, if the company is not found guilty, the company will
not have an actual liability.
In accounting, a contingent liability and the related contingent loss are recorded
with a journal entry only if the contingency is both probable and the amount can
be estimated.
If a contingent liability is only possible (not probable), or if the amount cannot
be estimated, a journal entry is not required. However, a disclosure is required.
When a contingent liability is remote (such as a nuisance suit), then neither a
journal nor a disclosure is required.
A product warranty is often cited as a contingent liability that is both probable
and can be estimated. Additional examples and a further explanation are
presented in FASB's Statement of Financial Accounting Standards No. 5,
Accounting for Contingencies.
Question 6. What Is Owner's Equity?
Answer :
Owner's equity is one of the three main components of a sole proprietorship's
balance sheet and accounting equation. Owner's equity represents the owner's
investment in the business minus the owner's draws or withdrawals from the
business plus the net income (or minus the net loss) since the business began.
Mathematically, the amount of owner's equity is the amount of assets minus the
amount of liabilities. Since the amounts must follow the cost principle (and
others) the amount of owner's equity does not represent the current fair market
value of the business.
Owner's equity is viewed as a residual claim on the business assets because
liabilities have a higher claim. Owner's equity can also be viewed (along with
liabilities) as a source of the business assets.
Question 7. What Are Accrued Expenses And When Are They
Recorded?
Answer :
Accrued expenses are expenses that have occurred but are not yet recorded
through the normal processing of transactions. Since these expenses are not yet
in the accountant's general ledger, they will not appear on the financial
statements unless an adjusting entry is entered prior to the preparation of the
financial statements.
Here is an example. A company borrowed $200,000 on December 1. The
agreement requires that the $200,000 be repaid on February 28 along with
$6,000 of interest for the three months of December through February. As of
December 31 the company will not have an invoice or payment for the interest
that the company is incurring. (The reason is that all of the interest will be due
on February 28.)
Without an adjusting entry to accrue the interest expense that the company has
incurred in December, the company's financial statements as of December 31
will not be reporting the $2,000 of interest (one-third of the $6,000) that the
company has incurred in December. In order for the financial statements to be
correct on the accrual basis of accounting, the accountant needs to record an
adjusting entry dated as of December 31. The adjusting entry will consist of a
debit of $2,000 to Interest Expense (an income statement account) and a credit
of $2,000 to Interest Payable (a balance sheet account).
Question 8. What Is The Difference Between Financial Accounting
And Management Accounting?
Answer :
Financial accounting has its focus on the financial statements which are
distributed to stockholders, lenders, financial analysts, and others outside of the
company. Courses in financial accounting cover the generally accepted
accounting principles which must be followed when reporting the results of a
corporation's past transactions on its balance sheet, income statement, statement
of cash flows, and statement of changes in stockholders' equity.
Managerial accounting has its focus on providing information within the
company so that its management can operate the company more effectively.
Managerial accounting and cost accounting also provide instructions on
computing the cost of products at a manufacturing enterprise. These costs will
then be used in the external financial statements. In addition to cost systems for
manufacturers, courses in managerial accounting will include topics such as cost
behavior, break-even point, profit planning, operational budgeting, capital
budgeting, relevant costs for decision making, activity based costing, and
standard costing.
Question 9. What Is The Cost Of Goods Sold?
Answer :
The cost of goods sold is the cost of the merchandise that a retailer, distributor,
or manufacturer has sold.
The cost of goods sold is reported on the income statement and can be
considered as an expense of the accounting period. By matching the cost of the
goods sold with the revenues from the goods sold, the matching principle of
accounting is achieved.
The sales revenues minus the cost of goods sold is gross profit.
Cost of goods sold is calculated in one of two ways. One way is to adjust the
cost of the goods purchased or manufactured by the change in inventory of
finished goods. For example, if 1,000 units were purchased or manufactured but
inventory increased by 100 units then the cost of 900 units will be the cost of
goods sold. If 1,000 units were purchased but the inventory decreased by 100
units then the cost of 1,100 units will be the cost of goods sold.
The second way to calculate the cost of goods sold is to use the following costs:
beginning inventory + the cost of goods purchased or manufactured = cost of
goods available – ending inventory.
When costs change during the accounting period, a cost flow will have to be
assumed. Cost flow assumptions include FIFO, LIFO, and average.
Question 10. What Is The Difference Between Product Costs And
Period Costs?
Answer :
A manufacturer's product costs are the direct materials, direct labor, and
manufacturing overhead used in making its products. (Manufacturing overhead
is also referred to as factory overhead, indirect manufacturing costs, and
burden.) The product costs of direct materials, direct labor, and manufacturing
overhead are also "inventoriable" costs, since these are the necessary costs of
manufacturing the products.
Period costs are not a necessary part of the manufacturing process. As a result,
period costs cannot be assigned to the products or to the cost of inventory. The
period costs are usually associated with the selling function of the business or its
general administration. The period costs are reported as expenses in the
accounting period in which they 1) best match with revenues, 2) when they
expire, or 3) in the current accounting period. In addition to the selling and
general administrative expenses, most interest expense is a period expense.
Question 11. What Is The Difference Between An Implicit Cost And
An Explicit Cost?
Answer :
An implicit cost is a cost that has occurred but it is not initially shown or
reported as a separate cost. On the other hand, an explicit cost is one that has
occurred and is clearly reported as a separate cost. Below are some examples to
illustrate the difference between an implicit cost and an explicit cost.
Let's assume that a company gives a promissory note for $10,000 to someone in
exchange for a unique used machine for which the fair value is not known. The
note will come due in three years and it does not specify any interest. Due to the
company's weak financial position it will have to pay a high interest rate if it
were to borrow money. In this example, there is no explicit interest cost.
However, due to the issuer's financial difficulty and the seller having to wait
three years to collect the money, there has to be some interest cost. In other
words, there is some interest and it is implicit. To properly record the note and
the machine, the accountant must determine the amount of the interest, which is
known as imputing the interest. In effect the accountant must convert the
implicit interest to explicit interest. This is done by discounting the $10,000 by
using the interest rate that the issuer of the note would have to pay to another
lender. If the rate is 12% per year, the interest that was implicit in the note is
$2,880 and the principal portion of the note is the remaining $7,120.
If another company with the same financial condition purchased this unique
machine by issuing a $7,120 note with a stated interest rate of 12% per year, the
interest cost of $2,880 would be explicit. In this situation, there is no need to
impute the interest.
Question 12. What Is The Double Declining Balance Method Of
Depreciation?
Answer :
The double declining balance method of depreciation, also known as the 200%
declining balance method of depreciation, is a common form of accelerated
depreciation. Accelerated depreciation means that an asset will be depreciated
faster than would be the case under the straight line method. Although the
depreciation will be faster, the total depreciation over the life of the asset will
not be greater than the total depreciation using the straight line method. This
means that the double declining balance method will result in greater
depreciation expense in each of the early years of an asset's life and smaller
depreciation expense in the later years of an asset's life as compared to straight
line depreciation.
Under the double declining balance method, double means twice or 200% of the
straight line depreciation rate. Declining balance refers to the asset's book value
or carrying value at the beginning of the accounting period. Book value is an
asset's cost minus its accumulated depreciation. The asset's book value will
decrease when the contra asset account Accumulated Depreciation is credited
with the depreciation expense of the accounting period.
Let's illustrate double declining balance depreciation with an asset that is
purchased on January 1 at a cost of $100,000 and is expected to have no salvage
value at the end of its useful life of 10 years. Under the straight line method, the
10 year life means the asset's annual depreciation will be 10% of the asset's cost.
Under the double declining balance method the 10% straight line rate is doubled
to be 20%. However, the 20% is multiplied times the asset's beginning of the
year book value instead of the asset's original cost. At the beginning of the first
year, the asset's book value is $100,000 since there has not yet been any
depreciation recorded. Therefore, under the double declining balance method the
$100,000 of book value will be multiplied by 20% for depreciation in Year 1 of
$20,000. The journal entry will be a debit of $20,000 to Depreciation Expense
and a credit to Accumulated Depreciation of $20,000.
At the beginning of the second year, the asset's book value will be $80,000. This
is the asset's cost of $100,000 minus its accumulated depreciation of $20,000.
The $80,000 of beginning book value multiplied by 20% results in $16,000. The
depreciation entry for Year 2 will be a debit to Depreciation Expense for
$16,000 and a credit to Accumulated Depreciation for $16,000.
At the beginning of Year 3, the asset's book value will be $64,000. This is the
asset's cost of $100,000 minus its accumulated depreciation of $36,000 ($20,000
+ $16,000). The book value of $64,000 X 20% = $12,800 of depreciation
expense for Year 3.
At the beginning of Year 4, the asset's book value will be $51,200. This is the
asset's cost of $100,000 minus its accumulated depreciation of $48,800 ($20,000
+ $16,000 + $12,800). The book value of $51,200 X 20% = $10,240 of
depreciation expense for Year 4.
As you can see, the amount of depreciation expense is declining each year. Over
the remaining six years there can be only $40,960 of additional depreciation.
This is the asset's cost of $100,000 minus its accumulated depreciation of
$59,040. Some people will switch to straight line at this point and record the
remaining $40,960 over the remaining 6 years in equal amounts of $6,827 per
year. Others may choose to follow the original formula.
Question 13. What Is The Matching Principle?
Answer :
The matching principle is one of the basic underlying guidelines in accounting.
The matching principle directs a company to report an expense on its income
statement in the same period as the related revenues.
To illustrate the matching principle, let's assume that all of a company's sales are
made through sales representatives (reps) who earn a 10% commission. The
commissions for each calendar month's sales are paid to the reps on the 15th day
of the following month. For example, if the company has $60,000 of sales in
December, the company will pay commissions of $6,000 on January 15. The
matching principle requires that $6,000 of commission expense be reported on
the December income statement along with the related December sales of
$60,000. This is likely to be carried out through an adjusting entry on December
31 that debits Commission Expense and credits Commissions Payable for
$6,000.
The matching principle is associated with the accrual method of accounting and
adjusting entries. Without the matching principle, the company might report the
$6,000 of commission expense in January (when it is paid) instead of December
(when the expense and the liability are incurred).
A retailer's or a manufacturer's cost of goods sold is another example of an
expense that is matched with sales through a cause and effect relationship.
However, not all costs and expenses have a cause and effect relationship with
sales or revenues. Hence, the matching principle may require a systematic
allocation of a cost to the accounting periods in which the cost is used up. For
example, if a company purchases an elaborate office system for $252,000 that
will be useful for 84 months, the company will match $3,000 of expense each
month to its monthly income statement.
Question 14. What Is Absorption Costing?
Answer :
Absorption costing means that all of the manufacturing costs are absorbed by
the units produced. In other words, the cost of a finished unit in inventory will
include direct materials, direct labor, and both variable and fixed manufacturing
overhead. As a result, absorption costing is also referred to as full costing or the
full absorption method.
Absorption costing is often contrasted with variable costing or direct costing.
Under variable or direct costing, the fixed manufacturing overhead costs are not
allocated or assigned to (not absorbed by) the products manufactured. Variable
costing is often useful for management's decision-making. However, absorption
costing is required for external financial reporting and for income tax reporting.
Question 15. What Are Prepaid Expenses?
Answer :
Prepaid expenses are future expenses that have been paid in advance. You can
think of prepaid expenses as costs that have been paid but have not yet been
used up or have not yet expired.
The amount of prepaid expenses that have not yet expired are reported on a
company's balance sheet as an asset. As the amount expires, the asset is reduced
and an expense is recorded for the amount of the reduction. Hence, the balance
sheet reports the unexpired costs and the income statement reports the expired
costs. The amount reported on the income statement should be the amount that
pertains to the time interval shown in the statement's heading.
A common prepaid expense is the six-month premium for insurance on a
company's vehicles. Since the insurance company requires payment in advance,
the amount paid is often recorded in the current asset account Prepaid Insurance.
If the company issues monthly financial statements, its income statement will
report Insurance Expense that is one-sixth of the amount paid. The balance in
the account Prepaid Insurance will be reduced by the amount that was debited to
Insurance Expense.
Question 16. What Is The Difference Between Stocks And Bonds?
Answer :
Stocks, or shares of stock, represent an ownership interest in a corporation.
Bonds are a form of long-term debt in which the issuing corporation promises to
pay the principal amount at a specific date.
Stocks pay dividends to the owners, but only if the corporation declares a
dividend. Dividends are a distribution of a corporation's profits. Bonds pay
interest to the bondholders. Generally, the bond contract requires that a fixed
interest payment be made every six months.
Every corporation has common stock. Some corporations issue preferred stock
in addition to its common stock. Many corporations do not issue bonds.
The stocks and bonds issued by the largest corporations are often traded on
stock and bond exchanges. Stocks and bonds of smaller corporations are often
held by investors and are never traded on an exchange.
Question 17. How Do You Calculate Accrued Vacation Pay?
Answer :
Accrued vacation pay is the amount of vacation pay which has been earned by
the employee but has not yet been paid to the employee.
To illustrate accrued vacation time and accrued vacation pay let's assume that
the employee's contract guarantees 120 hours of paid vacation time per year (40
hour work week times 3 weeks). If the employee's hourly pay rate is $26 per
hour, the employee is earning vacation pay of $3,120 per year (120 hours x
$26), or $60 per week ($3,120 per year divided by 52 weeks). The company is
also incurring vacation pay expense and a liability of $60 per week. In terms of
vacation time, the employee is earning 2.31 hours of vacation time each week
(120 hours per year divided by 52 weeks per year) or 2.45 hours based on 120
hours divided by the 49 weeks not on vacation.
At December 31 the company has a liability for the vacation hours and vacation
pay that the employee has earned and is entitled to if the company were to close.
If the employee has worked 20 weeks since the employee's anniversary date
with the company and the last vacation payment, then the company should
report a current liability of $1,200 (20 weeks x $60 per week.)
Question 18. Why Is Depreciation On The Income Statement Different
From The Depreciation On The Balance Sheet?
Answer :
Depreciation on the income statement is the amount of depreciation expense that
is appropriate for the period of time indicated in the heading of the income
statement. The depreciation reported on the balance sheet is the accumulated or
the cumulative total amount of depreciation that has been reported as expense on
the income statement from the time the assets were acquired until the date of the
balance sheet.
Let's illustrate the difference with an example. A company has only one
depreciable asset that was acquired three years ago at a cost of $120,000. The
asset is expected to have a useful life of 10 years and no salvage value. The
company uses straight-line depreciation on its monthly financial statements. In
the asset's 36th month of service, the monthly income statement will report
depreciation expense of $1,000. On the balance sheet dated as of the last day of
the 36th month, accumulated depreciation will be reported as $36,000. In the
37th month, the income statement will report $1,000 of depreciation expense. At
the end of the 37th month, the balance sheet will report accumulated
depreciation of $37,000.
Question 19. What Is Depreciation?
Answer :
Depreciation is the assigning or allocating of a plant asset's cost to expense over
the accounting periods that the asset is likely to be used. For example, if a
business purchases a delivery truck with a cost of $100,000 and it is expected to
be used for 5 years, the business might have depreciation expense of $20,000 in
each of the five years. (The amounts can vary depending on the method and
assumptions.)
In our example, each year there will be an adjusting entry with a debit to
Depreciation Expense for $20,000 and a credit to Accumulated Depreciation for
$20,000. Since the adjusting entries do not involve cash, depreciation expense is
referred to as a noncash expense.
Question 20. What Is Goodwill?
Answer :
In accounting, goodwill is an intangible asset associated with a business
combination. Goodwill is recorded when a company acquires (purchases)
another company and the purchase price is greater than the combination or net
of 1) the fair value of the identifiable tangible and intangible assets acquired,
and 2) the liabilities that were assumed.
Goodwill is reported on the balance sheet as a noncurrent asset. Since 2001,
U.S. companies are no longer required to amortize the recorded amount of
goodwill. However, the amount of goodwill is subject to a goodwill impairment
test at least once per year. (Beginning in 2015, private companies may opt to
amortize goodwill generally over a 10-year period and thereby minimize the
cost and complexity involved with testing for impairment.)
Outside of accounting, goodwill could refer to some value that has been
developed within a company as a result of delivering amazing customer service,
unique management, teamwork, etc. This goodwill, which is unrelated to a
business combination, is not recorded or reported on the company's balance
sheet.
Question 21. What Is Principles Of Accounting?
Answer :
Three meanings come to mind when you ask about principles of
accounting:
o Principles of Accounting was often the title of the introductory course
in accounting. It was also common for the textbook used in the course
to be entitled Principles of Accounting.
o Principles of accounting can also refer to the basic or fundamental
accounting principles: cost principles, matching principles, full
disclosure principles, materiality principles, going concern principles,
economic entity principles, and so on. In this context, principles of
accounting refers to the broad underlying concepts which guide
accountants when preparing financial statements.
o Principles of accounting can also mean generally accepted accounting
principles (GAAP). When used in this context, principles of accounting
will include both the underlying basic accounting principles and the
official accounting pronouncements issued by the Financial Accounting
Standards Board (FASB) and its predecessor organizations. The official
pronouncements are detailed rules or standards for specific topics.
Question 22. What Is Gaap?
Answer :
GAAP is the acronym for generally accepted accounting principles. In the U.S.
that means
o the basic accounting principles and guidelines such as the cost
principle, matching principle, full disclosure, etc.,
o the detailed standards and other rules issued by the Financial
Accounting Standards Board (FASB) and its predecessor the
Accounting Principles Board, and
o generally accepted industry practices.
GAAP must be adhered to when a company distributes its financial statements
outside of the company. If a corporation's stock is publicly traded, the financial
statements must also adhere to rules established by the U.S. Securities and
Exchange Commission (SEC). This includes having its financial statements
audited by an independent CPA firm.
Question 23. What Is Deferred Revenue?
Answer :
Deferred revenue is not yet revenue. It is an amount that was received by a
company in advance of earning it. The amount unearned (and therefore
deferred) as of the date of the financial statements should be reported as a
liability. The title of the liability account might be Unearned Revenues or
Deferred Revenues.
When the deferred revenue becomes earned, an adjusting entry is prepared that
will debit the Unearned Revenues or Deferred Revenues account and will credit
Sales Revenues or Service Revenues.
Question 24. What Are Adjusting Entries?
Answer :
Adjusting entries are usually made on the last day of an accounting period (year,
quarter, month) so that the financial statements reflect the revenues that have
been earned and the expenses that were incurred during the accounting period.
Sometimes an adjusting entry is needed because:
o revenue has been earned, but it has not yet been recorded.
o an expense may have been incurred, but it hasn't yet been recorded.
o a company may have paid for six-months of insurance coverage, but
the accounting period is only one month. (This means that five months
of insurance expense is prepaid and should not be reported as an
expense on the current income statement.)
o a customer paid a company in advance of receiving goods or services.
Until the goods or services are delivered, the amount is reported as a
liability. After the goods or services are delivered, an entry is needed to
reduce the liability and to report the revenues.
A common characteristic of an adjusting entry is that it will involve one income
statement account and one balance sheet account. (The purpose of each
adjusting entry is to get both the income statement and the balance sheet to be
accurate.)
Question 25. Is There A Difference Between An Expense And An
Expenditure?
Answer :
An expense is reported on the income statement. An expense is a cost that has
expired, was used up, or was necessary in order to earn the revenues during the
time period indicated in the heading of the income statement. For example, the
cost of the goods that were sold during the period are considered to be expenses
along with other expenses such as advertising, salaries, interest, commissions,
rent, and so on.
An expenditure is a payment or disbursement. The expenditure may be for the
purchase of an asset, a reduction of a liability, a distribution to the owners, or it
could be an expense. For instance, an expenditure to eliminate a liability is not
an expense, while expenditures for advertising, salaries, etc. will likely be
recorded immediately as expenses.
Here's another example to illustrate the difference between an expense and an
expenditure. A company makes an expenditure of $255,500 to purchase
equipment. The expenditure occurs on a single day and the equipment is placed
in service. Assuming the equipment will be used for seven years, under the
straight line method of depreciation the cost of the equipment will be reported as
depreciation expense of $100 per day for the next 2,555 days (7 years of service
with 365 days each year).
Question 26. What Is The Difference Between Accounts Payable And
Accrued Expenses Payable?
Answer :
I would use the liability account Accounts Payable for suppliers' invoices that
have been received and must be paid. As a result, the balance in Accounts
Payable is likely to be a precise amount that agrees with supporting documents
such as invoices, agreements, etc.
I would use the liability account Accrued Expenses Payable for the accrual type
adjusting entries made at the end of the accounting period for items such as
utilities, interest, wages, and so on. The balance in the Accrued Expenses
Payable should be the total of the expenses that were incurred as of the date of
the balance sheet, but were not entered into the accounts because an invoice has
not been received or the payroll for the hourly wages has not yet been processed,
etc. The amounts recorded in Accrued Expenses Payable will often be estimated
amounts supported by logical calculations.
Question 27. What Is The Cost Principle?
Answer :
The cost principle is one of the basic underlying guidelines in accounting. It is
also known as the historical cost principle.
The cost principle requires that assets be recorded at the cash amount (or its
equivalent) at the time that an asset is acquired. For example, if equipment is
acquired for the cash amount of $50,000, the equipment will be recorded at
$50,000. If the equipment will be useful for 10 years with no salvage value, the
straight-line depreciation expense will be $5,000 per year (cost of $50,000
divided by 10 years). The equipment's market value, replacement cost or
inflation-adjusted cost will not affect the annual depreciation expense of $5,000.
The company's balance sheets will report the equipment's historical cost minus
the accumulated depreciation.
The cost principle also means that valuable brand names and logos that were
developed through effective advertising will not be reported as assets on the
balance sheet. This could result in a company's most valuable assets not being
included in the company's asset amounts. (On the other hand, a brand name that
is acquired through a transaction with another company will be reported on the
balance sheet at its cost.)
If a company has an asset that has a ready market with quoted prices, the
historical cost may be replaced with the current market value on each balance
sheet. An example is an investment consisting of shares of common stock that
are actively traded on a major stock exchange.
Question 28. What Is An Impairment?
Answer :
The term impairment is usually associated with a long-lived asset that has a
market which has decreased significantly. For example, a meat packing plant
may have recently spent large amounts for capital expenditures and then
experienced a dramatic drop in the plant's value due to business and community
conditions.
If the undiscounted future cash flows from the asset (including the sale amount)
are less than the asset's carrying amount, an impairment loss must be reported.
If the impairment loss must be reported, the amount of the impairment loss is
measured by subtracting the asset's fair value from its carrying value.
Question 29. What Is Bad Debts Expense?
Answer :
Bad debts expense often refers to the loss that a company experiences because it
sold goods or provided services and did not require immediate payment. The
loss occurs when the customer does not pay the amount owed. In other words,
bad debts expense is related to a company's current asset accounts receivable.
It is common to see two methods for computing the amount of bad debts
expense:
o direct write-off method
o allowance method
The direct write-off method requires that a customer's uncollectible account be
first identified and then removed from the account Accounts Receivable. This
method is required for U.S. income taxes and results in a debit to Bad Debts
Expense and a credit to Accounts Receivable for the amount that is written off.
The allowance method anticipates that some of the accounts receivable will not
be collected. In other words, prior to knowing exactly which customers or
clients will not be paying, the company will debit Bad Debts Expense and will
credit Allowance for Doubtful Accounts for an estimated, anticipated amount.
(The Allowance for Doubtful Accounts is a contra asset account that when
combined with Accounts Receivable indicates a more realistic amount that will
be turning to cash.)
Many believe that the allowance method is the better method since 1) the
balance sheet will be reporting a more realistic amount that will be collected
from the company's accounts receivable, and 2) the bad debts expense will be
reported on the income statement closer to the time of the related credit sales.
Question 30. How Do You Record A Payment For Insurance?
Answer :
Since insurance premiums are usually paid prior to the period covered by the
payment, it is common to debit Prepaid Insurance and to credit Cash for the
amount paid. (Prepaid Insurance is a current asset and is reported on the balance
sheet after inventory.)
As the prepaid amount expires, the balance in Prepaid Insurance is reduced by a
credit to Prepaid Insurance and a debit to Insurance Expense. This is done with
an adjusting entry at the end of each accounting period (e.g. monthly). One
objective of the adjusting entry is to match the proper amount of insurance
expense to the period indicated on the income statement. (The income statement
should report the amount of insurance that has expired during the period
indicated in the income statement's heading.) Another objective is to report on
the balance sheet the unexpired amount of insurance as the asset Prepaid
Insurance.
If you can arrange for your insurance payments to be the amount applicable to
each accounting period, you can simply debit Insurance Expense and credit
Cash. For example, if the insurance premiums for one year amount to $12,000
and you can pay the insurance company $1,000 per month, then each monthly
payment will be recorded with a debit to Insurance Expense and a credit to
Cash. In this case $1,000 per month will be matched on the income statement
and there will be no prepaid amount to be reported on the balance sheet.
Question 31. Where Does Revenue Received In Advance Go On A
Balance Sheet?
Answer :
Revenues received in advance are reported as a current liability if they will be
earned within one year. The accounting entry is a debit to the asset Cash for the
amount received and a credit to the liability account such as Customer Advances
or Unearned Revenues.
As the amount received in advance is earned, the current liability account will
be debited for the amount earned and the Revenues account reported on the
income statement will be credited. This is done through an adjusting entry.
Question 32. How Do You Report A Write-down In Inventory?
Answer :
A write-down in a company's inventory is recorded by reducing the amount
reported as inventory. In other words, the asset account Inventory is reduced by
a credit or a contra inventory account is credited. The debit in the entry to write
down inventory is reported in an account such as Loss on Write-Down of
Inventory, an income statement account.
If the amount of the Loss on Write-Down of Inventory is relatively small, it can
be reported as part of the cost of goods sold. If the amount of the Loss on Write-
Down of Inventory is significant, it should be reported as a separate line on the
income statement.
Since the amount of the write-down of inventory reduces net income, it will also
reduce the amount reported as owner's equity or stockholders' equity. Hence for
the balance sheet and in the accounting equation, the asset inventory is reduced
and the owner's or stockholders' equity is reduced.
Question 33. What Is Materiality?
Answer :
In accounting, the concept of materiality allows you to violate another
accounting principle if the amount is so small that the reader of the financial
statements will not be misled.
A classic example of the materiality concept or the materiality principle is the
immediate expensing of a $10 wastebasket that has a useful life of 10 years. The
matching principle directs you to record the wastebasket as an asset and then
depreciate its cost over its useful life of 10 years. The materiality principle
allows you to expense the entire $10 in the year it is acquired instead of
recording depreciation expense of $1 per year for 10 years. The reason is that no
investor, creditor, or other interested party would be misled by not depreciating
the wastebasket over a 10-year period.
Determining what is a material or significant amount can require professional
judgment. For example, $5,000 might be immaterial for a large, profitable
corporation, but it will be material or significant for a small company that has
very little profit.
Question 34. What Are Operating Expenses?
Answer :
Operating expenses are the costs associated with a company's main operating
activities and which are reported on its income statement.
For example, a retailer's main operating activities are the buying and selling of
merchandise or goods.
Therefore, its operating expenses will include:
o Cost of goods sold. These costs are reported as operating expenses on
the income statement because of the matching principle. The revenues
from the sale of merchandise must be matched with the cost of the
merchandise that is sold.
o Selling, general and administrative expenses (SG&A). These costs are
reported as operating expenses on the income statement because they
pertain to operating the main business during that accounting period.
These costs may have expired, may have been used up, or may not have
a future value that can be measured.
Some authors define operating expenses as only SG&A. In other words, they do
not include the cost of goods sold as an operating expense. Such a definition will
be deficient for calculating a company's operating income. Clearly, the
calculation of operating income cannot omit the cost of goods sold.
Question 35. What Is Interest Expense?
Answer :
Interest expense is the cost of debt that has occurred during a specified period of
time.
To illustrate interest expense under the accrual method of accounting, let's
assume that a company borrows $100,000 on December 15 and agrees to pay
the interest on the 15th of each month beginning on January 15. The loan states
that the interest is 1% per month on the loan balance. The interest expense for
the month of December will be approximately $500 ($100,000 x 1% x 1/2
month). The interest expense for the month of January will be $1,000 ($100,000
x 1%).
Since interest on debt is not paid daily, a company must record an adjusting
entry to accrue interest expense and to report interest payable. Using our
example above, at December 31 no interest was yet paid on the loan that began
on December 15. However, the company did incur one-half month of interest
expense. Therefore, the company needs to record an adjusting entry that debits
Interest Expense $500, and credits Interest Payable for $500.
Question 36. What Is Working Capital?
Answer :
Working capital is the amount of a company's current assets minus the amount
of its current liabilities. For example, if a company's balance sheet dated June 30
reports total current assets of $323,000 and total current liabilities of $310,000
the company's working capital on June 30 was $13,000. If another company has
total current assets of $210,000 and total current liabilities of $60,000 its
working capital is $150,000.
The adequacy of a company's working capital depends on the industry in which
it competes, its relationship with its customers and suppliers, and more. Here are
some additional factors to consider:
o The types of current assets and how quickly they can be converted to
cash. If the majority of the company's current assets are cash and cash
equivalents and marketable investments, a smaller amount of working
capital may be sufficient. However, if the current assets include slow-
moving inventory items, a greater amount of working capital will be
needed.
o The nature of the company's sales and how customers pay. If a
company has very consistent sales via the Internet and its customers
pay with credit cards at the time they place the order, a small amount of
working capital may be sufficient. On the other hand, a company in an
industry where the credit terms are net 60 days and its suppliers must
be paid in 30 days, the company will need a greater amount of working
capital.
o The existence of an approved credit line and no borrowing. An
approved credit line and no borrowing allows a company to operate
comfortably with a small amount of working capital.
o How accounting principles are applied. Some companies are
conservative in their accounting policies. For instance, they might have
a significant credit balance in their allowance for doubtful accounts and
will dispose of slow-moving inventory items. Other companies might
not provide for doubtful accounts and will keep slow-moving items in
inventory at their full cost.
In short, analyzing working capital should involve more than simply subtracting
current liabilities from current assets.
Question 37. How Do I Compute The Units Of Production Method Of
Depreciation?
Answer :
The units of production method of depreciation is based on an asset's usage,
activity, or parts produced instead of the passage of time. Under the units of
production method, depreciation during a given year will be very high when
many units are produced, and it will be very low when only a few units are
produced.
To illustrate the units of production method, let's assume that a production
machine has a cost of $500,000 and its useful life is expected to end after
producing 240,000 units of a component part. The salvage value at that point is
expected to be $20,000. Under the units of production method, the machine's
depreciable cost of $480,000 ($500,000 minus $20,000) is divided by 240,000
units, resulting in depreciation of $2 per unit. If the machine produces 10,000
parts in the first year, the depreciation for the year will be $20,000 ($2 x 10,000
units). If the machine produces 50,000 parts in the next year, its depreciation
will be $100,000 ($2 x 50,000 units). The depreciation will be calculated
similarly each year until the asset's Accumulated Depreciation reaches
$480,000.
The units of production method is also referred to as the units of activity
method, since the method can be used for depreciating airplanes based on air
miles, cars on miles driven, photocopiers on copies made, DVDs on number of
times rented, and so on.
Depreciation is an allocation technique and the units of production method
might do a better job of allocating/matching an asset's cost to the proper period
than the straight-line method, which is based solely on the passage of time.
Question 38. What Are The Effects Of Depreciation?
Answer :
The depreciation of assets such as equipment, buildings, furnishing, trucks, etc.
causes a corporation's asset amounts, net income, and stockholders' equity to
decrease. This occurs through an accounting adjusting entry in which the
account Depreciation Expense is debited and the contra asset account
Accumulated Depreciation is credited.
The amount of the annual depreciation that is reported on the financial
statements is an estimate based on the asset's 1) cost, 2) estimated salvage value,
and 3) useful life. Depreciation should be thought of as an allocation of the
asset's cost to expense (and not as a valuation technique). In other words, the
accountant is matching the cost of the asset to the periods in which revenues are
generated from the asset.
The amount of the annual depreciation reported on the U.S. income tax return is
based on the tax regulations. Since depreciation is a deductible expense for
income tax purposes, the corporation's taxable income (and associated tax
payments) will be reduced by its tax depreciation expense. (In any one year, the
depreciation expense for taxes will likely be different from the amount reported
on the financial statements.)
It should be noted that depreciation is viewed as a noncash expense. That is, the
corporation's cash balance is not changed by the annual depreciation entry.
(Often the corporation's cash is reduced for the asset's entire cost at the time the
asset is acquired.)
Question 39. What Is The Difference Between Net Cash Flow And Net
Income?
Answer :
Under the accrual method of accounting, net income is calculated as follows:
revenues earned minus the expenses incurred in order to earn those revenues. If
a company earns revenues in December but allows those customers to pay in 30
days, the cash from the December revenues will likely be received in January. In
this situation the December revenues will increase the December net income,
but will not increase the company's December net cash flow.
Under accrual accounting, expenses are matched to the accounting period when
the related revenues occur or when the costs have expired. For example, a
retailer may have purchased and paid for merchandise in October. However, the
merchandise remained in inventory until it was sold in December. The
company's net cash flow decreases in October when the company pays for the
merchandise. However, net income decreases in December when the cost of the
goods sold is matched with the December sales.
There are many other examples of expenses occurring in one accounting period
but the payments occur in a different accounting period. In short, the statement
of cash flows is a needed financial statement because the income statement does
not report cash flows.
Question 40. What Is Historical Cost?
Answer :
Historical cost is a term used instead of the term cost. Cost and historical cost
usually mean the original cost at the time of a transaction. The term historical
cost helps to distinguish an asset's original cost from its replacement cost,
current cost, or inflation-adjusted cost. For example, land purchased in 1992 at
cost of $80,000 and still owned by the buyer will be reported on the buyer's
balance sheet at its cost or historical cost of $80,000 even though its current
cost, replacement cost, and inflation-adjusted cost is much higher today.
The cost principle or historical cost principle states that an asset should be
reported at its cost (cash or cash equivalent amount) at the time of the exchange
transaction and should include all costs necessary to get the asset in place and
ready for use.
Question 41. Where Are Accruals Reflected On The Balance Sheet?
Answer :
Accrued expenses are reported in the current liabilities section of the balance
sheet. Accrued expenses reported as current liabilities are the expenses that a
company has incurred as of the balance sheet date, but have not yet been
recorded or paid. Typical accrued expenses include wages, interest, utilities,
repairs, bonuses, and taxes.
Accrued revenues are reported in the current assets section of the balance sheet.
The accrued revenues reported on the balance sheet are the amounts earned by
the company as of the balance sheet date that have not yet been recorded and the
customers have not yet paid the company.
Accrued expenses and accrued revenues are also reflected in the income
statement and in the statement of cash flows prepared under the indirect method.
However, these financial statements reflect a time period instead of a point in
time.
Question 42. What Is Prepaid Insurance?
Answer :
Prepaid insurance is the portion of an insurance premium that has been paid in
advance and has not expired as of the date of the balance sheet. This unexpired
cost is reported in the current asset account Prepaid Insurance.
As the amount of prepaid insurance expires, the expired cost is moved from the
asset account Prepaid Insurance to the income statement account Insurance
Expense. This is usually done at the end of each accounting period through an
adjusting entry.
To illustrate prepaid insurance, let's assume that on November 20 a company
pays an insurance premium of $2,400 for the six-month period of December 1
through May 31. On November 20, the payment is entered with a debit of
$2,400 to Prepaid Insurance and a credit of $2,400 to Cash. As of November 30
none of the $2,400 has expired and the entire $2,400 will be reported as Prepaid
Insurance. On December 31, an adjusting entry will debit Insurance Expense for
$400 (the amount that expired: 1/6 of $2,400) and will credit Prepaid Insurance
for $400. This means that the debit balance in Prepaid Insurance at December 31
will be $2,000 (5 months of insurance that has not yet expired times $400 per
month; or 5/6 of the $2,400 insurance premium cost).
 Question 43. What Is A Long-term Liability?
Answer :
A long-term liability is a noncurrent liability. That is, a long-term liability is an
obligation that is not due within one year of the date of the balance sheet (or not
due within the company's operating cycle if it is longer than one year).
Some examples of long-term liabilities are the noncurrent portions of the
following:
o bonds payable
o long-term loans
o capital leases
o pension liabilities
o postretirement healthcare liabilities
o deferred compensation
o deferred revenues
o deferred income taxes
o derivative liabilities
Some long-term debt that is due within one year of the balance sheet date
could continue to be reported as a long-term liability if there is:
o a long-term investment that is sufficient and restricted for the payment
of the debt, or
o intent and a financing arrangement that replaces the debt with new
long-term debt or with capital stock.
Question 44. What Are The Accounting Principles, Assumptions, And
Concepts?
Answer :
The basic or fundamental principles in accounting are the cost principle, full
disclosure principle, matching principle, revenue recognition principle,
economic entity assumption, monetary unit assumption, time period assumption,
going concern assumption, materiality, and conservatism. The last two are
sometimes referred to as constraints. Rather than distinguishing between a
principle or an assumption, I prefer to simply say that these ten items are the
basic principles or the underlying guidelines of accounting. (My reason is that
accounting principles also include the statements of financial accounting
standards and the interpretations issued by the Financial Accounting Standards
Board and its predecessors, as well as industry practices.)
There are also "qualities" of accounting information such as reliability,
relevance, consistency, comparability, and cost/benefit.
Question 45. How Do You Write Off A Bad Account?
Answer :
There are two ways to write off a bad account receivable. One is the direct
write-off method and the other occurs under the allowance method.
Under the direct write-off method a company writes off a bad account
receivable after the specific account is found to be uncollectible. This write off
usually occurs many months after the account receivable and the credit sale
were recorded. The entry to write off the bad account will consist of 1) a credit
to Accounts Receivable in order to remove the amount that will not be collected,
and 2) a debit to Bad Debts Expense to report the amount of the loss on the
company's income statement.
Under the allowance method a company anticipates that some of its credit sales
and accounts receivable will not be collected. In other words, without knowing
the specific accounts that will become uncollectible, the company debits Bad
Debts Expense and credits Allowance for Doubtful Accounts. This Allowance
account is a contra receivable account and it allows the company to report the
net amount of the receivables that it expects will be turning to cash prior to
identifying and removing a specific account receivable. When a specific
customer's account does present itself as uncollectible, the customer's account
will be written off by crediting Accounts Receivable and debiting Allowance for
Doubtful Accounts.
In the U.S. the direct write-off method is required for income tax purposes.
However, for financial reporting purposes the allowance method means
recognizing the loss (the bad debts expense) closer to the time of the credit sales.
As a result, the allowance method is more in line with the accountants' concept
of conservatism and may result in a better matching of the bad debt expense
with the credit sales.
Question 46. What Should Be The Entry When Goods Are Purchased
At A Discount?
Answer :
If you purchase $1000 of goods having a trade discount of 20%, you can debit
Purchases (periodic system) or Inventory (perpetual system) for $800 and
Accounts Payable for $800. This is consistent with the cost principle which
means the cash or cash equivalent amount.
If the invoice allows a 1% discount for paying within 10 days, you can record
the 1% discount when you make payment within the allotted time. The entry for
paying within 10 days would be: debit Accounts Payable $800, credit Cash for
$792, and credit Purchase Discounts $8 (or Inventory $8 if perpetual).
If you are certain to always pay vendor invoices within their discount periods,
you could initially record the above invoice at $792 (instead of $800). Debit
Purchases or Inventory for $792 and credit Accounts Payable $792. When
paying the invoice within the discount period, the entry would be a debit to
Accounts Payable for $792 and a credit to Cash for $792. If you fail to pay the
invoice within the discount period, the payment will have to be $800 and will be
recorded with a debit to Accounts Payable $792, a debit to Purchase Discounts
Lost $8, and a credit to Cash for $800.
Question 47. What Are Goods In Transit?
Answer :
Goods in transit refers to merchandise and other inventory items that have been
shipped by the seller, but have not yet been received by the purchaser.
To illustrate goods in transit, let's use the following example. Company J ships a
truckload of merchandise on December 30 to Customer K, which is located
2,000 miles away. The truckload of merchandise arrives at Customer K on
January 2. Between December 30 and January 2, the truckload of merchandise is
goods in transit. The goods in transit requires special attention if the companies
issue financial statements as of December 31. The reason is that the merchandise
is the inventory of one of the two companies, but the merchandise is not
physically present at either company. One of the two companies must add the
cost of the goods in transit to the cost of the inventory that it has in its
possession.
The terms of the sale will indicate which company should report the goods in
transit as its inventory as of December 31. If the terms are FOB shipping point,
the seller (Company J) will record a December sale and receivable, and will not
include the goods in transit as its inventory. On December 31, Customer K is the
owner of the goods in transit and will need to report a purchase, a payable, and
must add the cost of the goods in transit to the cost of the inventory which is in
its possession.
If the terms of the sale are FOB destination, Company J will not have a sale and
receivable until January 2. This means Company J must report the cost of the
goods in transit in its inventory on December 31. (Customer K will not have a
purchase, payable, or inventory of these goods until January 2.)
Question 48. What Is The Full Disclosure Principle?
Answer :
For a business, the full disclosure principle requires a company to provide the
necessary information so that people who are accustomed to reading financial
information can make informed decisions concerning the company.
The required disclosures can be found in a number of places including the
following:
 o the company's financial statements including any supplementary
schedules and notes (or footnotes).
o Management's Discussion and Analysis that is included in a publicly-
traded corporation's annual report to the U.S. Securities and Exchange
Commission.
o Quarterly earnings reports, press releases and other communications.
The first note or footnote in a company's financial statements will disclose the
significant accounting policies such as how and when revenues are recognized,
how property is depreciated, how inventory and income taxes are accounted for,
and more.
Other disclosures in the notes to the financial statements include the effects of
foreign currencies, contingent liabilities, leases, related-party transactions, stock
options, and much more.
Judgement is used in deciding the amount of information that is disclosed. For
example, in 1980 large U.S. corporations were required to report as
supplementary information the effects of inflation and changing prices on its
inventory and property (and cost of goods sold and depreciation expense). After
several years, the disclosure became optional since the cost of providing the
information exceeded the benefits.
Question 49. When Should Costs Be Expensed And When Should
Costs Be Capitalized?
Answer :
Costs should be expensed when they are used up or have expired and when they
have no future economic value which can be measured. For example, the August
salaries of a company's marketing team should be charged to expense in August
since the future economic value of their August salaries cannot be determined.
Costs should be capitalized or recorded as assets when the costs have not
expired and they have future economic value. For example, on November 25 a
company pays $12,000 for property insurance covering the six months of
December through May. The $12,000 is initially recorded as the current asset
Prepaid Insurance. On November 30 the company will report this asset at
$12,000 since the $12,000 has a future economic value. (It will save making
future payments of cash for insurance coverage.) On December 31 the asset will
be reported as $10,000—the unexpired cost.
It will also report Insurance Expense for the month of December as $2,000—the
cost that has expired during December. On January 31 the asset will be reported
at the unexpired cost of $8,000. January's insurance expense will be $2,000—the
amount that has expired during January.
 Question 50. Why Are Loan Costs Amortized?
Answer :
When loan costs are significant, they must be amortized because of the matching
principle. In other words, all of the costs of a loan must be matched to the
accounting periods when the loan is outstanding.
To clarify this, let's assume that a company incurs legal, accounting, and
registration fees of $120,000 during February in order to obtain a $4 million
loan at an annual interest rate of 9%. The loan will begin on March 1 and the
entire $4 million of principal will be due five years later. The company's cost of
the borrowed money will be $360,000 ($4 million X 9%) of interest each year
for five years plus the one-time loan costs of $120,000.
It would be misleading to report the entire $120,000 of loan costs as an expense
of one month. Hence, the matching principle requires that each month during the
life of the loan the company should report $2,000 ($120,000 divided by 60
months) of interest expense for the loan costs in addition to the interest expense
of $30,000 per month ($4 million X 9% per year = $360,000 per year divided by
12 months per year). The combination of the amortization of the loan cost plus
the interest expense will mean a total monthly interest expense of $32,000 for 60
months beginning on March 1.
Question 51. What Is A Capital Account?
Answer :
In accounting and bookkeeping, a capital account is one of the general ledger
accounts used to record 1) the amounts that were paid in to the company by an
investor, and 2) the cumulative amount of the company's earnings minus the
cumulative distributions to the owners. The balances of the capital accounts are
reported in the owner's equity, partners' equity, or stockholders' equity section of
the balance sheet.
In a corporation the capital accounts include:
o Paid-in capital accounts such as Common Stock, Preferred Stock, Paid-
in Capital in Excess of Par. These accounts report the amounts received
by the corporation when the shares of its capital stock were originally
issued to investors.
o Retained earnings accounts which typically contain the amount of the
corporation's cumulative earnings since the corporation was formed
minus the cumulative dividends distributed to the stockholders.

Treasury stock account (a contra account because it has a debit balance)

o Amy Fox, Capital. This account begins with Amy's original investment
and is increased for each year's earnings minus each year's withdrawals
by Amy.
o Amy Fox, Drawing. This account is a contra account because it will
have a debit balance equal to the amount of business assets that Amy
has withdrawn during the current accounting year for her personal use.
At the end of each accounting year, Amy's drawing account is closed
by transferring its debit balance to the account Amy Fox, Capital.
The total of the balances in the capital accounts must be equal to the reported
total of the company's assets minus its liabilities. Because of the historical cost
principle and other accounting principles the total amount reported in the capital
accounts will not indicate the company's market value or net worth.
Question 52. What Is Accrued Payroll?
Answer :
Accrued payroll would be wages, salaries, commissions, bonuses, and the
related payroll taxes and benefits that have been earned by a company's
employees, but have not yet been paid or recorded in the company's accounts.
For example, the accrued payroll as of December 31 would include all of the
wages that the hourly-paid employees have earned as of December 31, but will
not be paid until the following pay day (perhaps January 5). The employer's
portion of the FICA, unemployment taxes, worker compensation insurance, and
other benefits pertaining to those wages should also be included as accrued
payroll in order to achieve the matching principle of accounting.
Question 53. What Is Accrued Income?
Answer :
Accrued income is an amount that has been
o earned,
o there is a right to receive the amount, and
o it has not yet been recorded in the general ledger accounts. One
example of accrued income is the interest earned on a bond investment.
To illustrate, let's assume that a company invested $100,000 on December 1 in a
6% $100,000 bond that pays $3,000 of interest on each June 1 and December 1.
On December 31, the company will have earned one month's interest amounting
to $500 ($100,000 x 6% per year x 1/12 of a year, or 1/6 of the semiannual
$3,000). No interest will be received in December since it will be part of the
$3,000 to be received on June 1. The $500 of interest earned during December,
but not yet received or recorded as of December 31 is known as accrued income.
Under the accrual basis of accounting, accrued income is recorded with an
adjusting entry prior to issuing the financial statements. In our example, there
will need to be an adjusting entry dated December 31 that debits Interest
Receivable (a balance sheet account) for $500, and credits Interest Income (an
income statement account) for $500.