Accounting 2010- Ch. 3 Review Questions and Correct Answers

Accounting can either be based on what 2 types of accounting? 1. Accrual Accounting 2. Cash-Basis Accounting Accrual Accounting -Records what (2)? -Required by what? Accounting that records the impact of a business event as it occurs, regardless or whether the transaction affected cash. -Making the sale (not collecting the cash) increases your wealth Required by Generally Accepted Accounting Principles (GAAP) Records: ► Revenue when earned ► Expenses when incurred (not necessarily when cash changes hands) Cash-Basis Accounting -Records what? (2) -Ignores what? -Used by who? Accounting that records only transactions in which cash is received or paid Records only cash transactions ► Cash receipts ► Cash payments Ignores important information → Results in incomplete financial statements (Balance Sheet Defect and Income-Statement Defect) -Only used by small businesses Balance Sheet Defect Failing to record a sale on account with cash-basis accounting is bad b/c, the receivable represents a claim to receive cash in the future, which is a real asset. Therefore, IT SHOULD APPEAR on the balance sheet. W/o this information, the assets are understated on the balance sheet. Income Statement Defect A sale on account that is not recorded with cash-basis accounting provides revenue that increases the company's wealth. Ignoring the sale understates revenue and net income on the income statement. ________ __________ is a more faithful representation of economic reality. Accrual Accounting