Financial Accounting 4.0: Adjusting
Journal Entries | HBS CORE Study
Guide Exam Questions & Answers.
Explicit Transactions - CORRECT ANSWER Transactions that involve some activity, event, or exchange of
resources from one party to another. Explicit transactions are often accompanied by invoices or other
paper documentation that initiates the recording of the transaction.
Implicit Transactions - CORRECT ANSWER Transactions that do not involve a specific triggering activity,
event, or exchange of resources from one party to another, and that are not accompanied by an invoice
or other paper documentation. Often, implicit transactions represent changes in value related to the
passage of time, such as depreciation, interest expense, and the amortization of a prepaid expense.
Implicit transactions are often recorded using adjusting journal entries.
adjusting journal entries - CORRECT ANSWER which are implicit transactions. Implicit transactions do not
involve a specific triggering activity, event, or transfer of resources from one party to another. Often,
implicit transactions represent changes in value related to the passage of time.
There are four basic types of adjusting journal entries: - CORRECT ANSWER (1) Recognizing expenses
related to a prepaid asset
(2) Recognizing revenues related to deferred revenue (also called unearned revenue)
(3) Accruing of unrecorded expenses
(4) Accruing of unrecorded revenues
(1) Recognizing expenses related to a prepaid asset - CORRECT ANSWER Suppose a company pays cash
for one year's worth of rent. They will now have an asset account, prepaid rent, on their books. As each
month passes, that asset is worth less and less, and it will need to be reduced or expensed accordingly.
(2) Recognizing revenues related to deferred revenue (also called unearned revenue) - CORRECT
ANSWER Suppose a company receives cash from a customer for a year-long, monthly magazine
subscription. The company will now have an obligation to provide magazines to their customer. They
,will record a liability, deferred revenue, on their books. As each month passes, and the magazines are
provided, the liability account needs to be reduced and revenue needs to be recognized as earned.
(3) Accruing of unrecorded expenses - CORRECT ANSWER Entries related to unrecorded expenses usually
occur at the end of the accounting period, during the closing process. The purpose of this type of entry is
to account for any expenses that weren't recorded throughout the year because there was insufficient
information. Some examples would be accruing for property tax or interest expense, or accounting for
inventory shrinkage.
(4) Accruing of unrecorded revenues - CORRECT ANSWER Similar to the accrual for unrecorded
expenses, unrecorded revenues are usually accounted for at the end of the accounting period. This type
of entry reflects revenues that have been earned but not yet billed. For example, suppose a firm
provides consulting services for a client in December. At year end, the firm has yet to send the client a
bill for those services. Since the service has been provided, and the client will be billed eventually,
revenue must be recorded.
Here are some key indicators to look for in identifying implicit transactions: - CORRECT ANSWER (1) No
transfer of resources
(2) No invoices or other paper documentation
(3) No specific event or activity that clearly triggers a journal entry, just the passing of time
(4) Judgement regarding when to record and how much to record
Identify which of the following are explicit and which are implicit transactions and drag them to the
correct section. - CORRECT ANSWER Implicit:
- Recognizing depreciation on an office building
- Recognizing expense related to 6 months of prepaid rent usage
- Recognizing revenue related to prepaid subscription
- Recognizing expense related to one month of prepaid insurance usage
- Recording depreciation on a vehicle
Explicit:
- Taking out a bank loan
- Selling goods to customers in credit
,- Paying for one year of rent in advance
- Paying for one year of insurance in advance
- Paying wages to employees
The accrual method of accounting means - CORRECT ANSWER that companies record both explicit and
implicit transactions in the period in which they are incurred, which is not necessarily the same period in
which cash was paid or received.
In this lesson, we will talk first about accruals (transactions where cash changes hands after revenue or
expense is recognized) and then about deferrals (transactions where cash changes hands before
revenue or expense is recorded). Accruals and deferrals always involve revenues or expenses and are
the essence of two important concepts we have already covered—revenue recognition and the
matching principle. Many adjusting entries typically relate to either accruals or deferrals.
accruals - CORRECT ANSWER A revenue amount that is recorded after the revenue is earned but before
the payment is received or an expense amount that is recorded after it has been incurred but before the
payment has been made. In either case, for an accrual the exchange of cash is expected at some future
point after the initial revenue or expense is recognized.
Deferral - CORRECT ANSWER An amount that is recorded when payment is received for revenue that is
yet to be earned (such as deferred revenue/unearned revenue) or when payment has been made prior
to an expense being incurred (such as prepaid insurance). In either case, for a deferral the exchange of
cash takes place before the actual revenue or expense is recognized.
Build a journal entry:
As part of the 2013 year end close, your company evaluates any potential liabilities related to 2013
activities that will be paid in 2014. The company ran an advertising campaign in December for which you
agreed to pay $100,000, but you have not yet received the invoice.
What would the journal entry look like to record this obligation? - CORRECT ANSWER In this case, your
company has not received a bill but based on their evaluation concludes that there are obligations
coming from 2013 activities that will have to be settled in 2014. These obligations are recorded as
liabilities in 2013 because they relate to 2013 activities. You should debit Advertising Expenses for
$100,000 and credit Accrued Expenses (a liability account) for $100,000.
, Another way to look at accruals is - CORRECT ANSWER think of them as transactions where cash changes
hands after revenue or expense is recognized, and you can think of them as either accruals related to
revenue or accruals related to expenses.
Accruals related to revenue arise when - CORRECT ANSWER a company delivers goods or performs a
service before receiving payment. We have already seen examples of this when we learned about selling
on credit earlier in the course. When Cardullo's sells gift baskets on credit to Harvard's Society of
Fellows, Cardullo's immediately records a journal entry recognizing the revenue from the sale and
recording the amount in accounts receivable, even though cash will not be received until later. Accounts
receivable is the most common example of this type of accrual.
Accruals related to expenses arise when - CORRECT ANSWER a company uses resources before paying
for them. We have seen examples of this as well, when we learned about buying on credit earlier in the
course. When Bikram Yoga Natick has maintenance performed on the studio's heating system, Bikram
Yoga Natick immediately records a journal entry recognizing the expense and recording the amount in
accounts payable, even though cash will not be paid until later. Examples of this type of accrual include
interest payable, salaries payable, taxes payable, and utilities payable.
Which of the following is an example of Accrued Liabilities?
A company recorded wages expense for May on May 31, and will pay the wages on June 15.
A company paid its monthly office rental of June on June 1.
A company sold a piece of used equipment and recognized a loss. - CORRECT ANSWER A company
recorded wages expense for May on May 31, and will pay the wages on June 15.
Expense was recognized before cash was paid.
Which of the following is an example of Accrued Liabilities?
A company recorded its vehicle rental expense on June 30 and will pay this expense on July 31.
