Chapter 3
KNOWLEDGE CHECK 3.1
A hot dog vendor operates a cart in an urban park. Prepare journal entries for the following transactions:
- The vendor sells food items to customers during a day for $425 cash.
Dr. Cash (asset +)425
Cr. Sales (owners’ equity +)425
To record the sale of food for cash.
- The vendor purchases a supply of condiments for $300 cash.
Dr. Inventory—condiments (asset +)300
Cr. Cash (asset –)300
To record the purchase of condiments for cash.
- The vendor pays $250 on his bank loan.
Dr. Bank loan (liabilities –)250
Cr. Cash (asset –)250
To record payment on bank loan.
KNOWLEDGE CHECK 3.2
What is depreciation and why are capital assets depreciated?
Depreciation is the allocation of the cost of a capital asset to expense over the capital asset’s useful life. Depreciation is an example of matching. Since capital assets help an entity earn revenue their cost should be matched to the revenue they help earn.
What is the profit margin ratio and what does it mean?
The profit margin ratio is defined as:
Profit margin ratio / = / Net incomeSales
The profit margin ratio is a measure of how effective the entity is at controlling expenses and reflects the amount of income earned for each dollar of sales.
Describe the effect (increase or decrease) that debits and credits have on asset, liability, owners’ equity, revenue, and expense accounts.
Debit (Dr.) / Credit (Cr.)Increase assets / Decrease assets
Decrease liabilities / Increase liabilities
Decrease owners’ equity / Increase owners’ equity
Decrease revenues / Increase revenues
Increase expenses / Decrease expenses
KNOWLEDGE CHECK 3.3
Return to the Dahlia Ltd. example where Dahlia purchased its three-year insurance policy on July 1, 2017, for $9,000.
- What adjusting journal entries would be required on December 31, 2019 and 2020?
December 31, 2019 entry:
Dr. Insurance expense (expenses +, shareholders’ equity –)3,000
Cr. Prepaid insurance (asset –)3,000
To record the cost of insurance used from January 1, 2019 to December 31, 2019.
December 31, 2020 entry:
Dr. Insurance expense (expenses +, shareholders’ equity –)1,500
Cr. Prepaid insurance (asset –)1,500
To record the cost of insurance used from January 1, 2020 to December 31, 2020 (actually to June 30, 2020 since that’s when the policy expires).
KNOWLEDGE CHECK 3.4
Identify and explain the four types of adjusting journal entries.
There are four types of adjusting entries:
1.Deferred expense/prepaid expense—cash is paid before the expense is recognized;
2.Deferred revenue—cash is received before revenue is recognized;
3.Accrued expense/accrued liability—the expense is recognized before cash is paid
4.Accrued revenue/accrued asset—revenue is recognized before cash is received.
Explain what accrued expenses and accrued revenue are.
An accrued expense is an expense that is recognized (recorded) in the financial statements before the cash payment is made. Accrued revenue is revenue that is recognized (recorded) before cash is received.
What is a contra-asset account?
A contra-asset account is an account that’s used to accumulate amounts deducted from a related asset account. For example, the accumulated depreciation account is a contra-asset account to capital asset accounts.
What are closing journal entries and why are they necessary?
All accounts that are reported on the income statement are referred to as temporary accounts. They are temporary because at the end of each period they are reset to zero so that accumulation of revenues and expenses can begin anew in the next period. The process of resetting temporary account balances to zero and transferring the balances to retained earnings or owners’ equity is accomplished using closing journal entries.