Chapter 3

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Conservatism means that if there is uncertainty in a potential financial estimate, a company should err on the side of caution and report the most conservative amount. For the example, answers will vary. Sample answer: When I am budgeting for revenue in our household, I estimate what amount we will be paid, and I always round slightly down and with the expenses round up slightly so that there is a little leftover.

Assets = Liabilities + Equity; Revenues increase equity, while expenses decrease equity.

The general journal.

Decreasing cash decreases assets; decreasing accounts payable decreases liabilities. Assets (decrease) = Liabilities (decrease) + Equity (no change).

The combined total of liabilities and equity equals the total of assets because there is a claim against every asset that the company owns. Creditors have claims against some of the company’s assets, in the amount of the liabilities owed to them; owners (stockholders) have claims against all the rest of the company’s assets. Equity is the total of assets minus liabilities, which is sometimes referred to as net assets.

The total in accounts receivable will increase with a debit. We know this because accounts receivable is an asset account, and asset balances increase with debit entries.

A journal is a chronological listing of all of the recordable transactions that have occurred in a company.

Recognize means to make a journal entry.

It is a comprehensive listing for all accounts a company has and their balances.

T-accounts represent the changes made to the general ledger. They are used as an illustrative tool when planning or discussing the effects a particular transaction will have on the accounting records. T-accounts are used in academic and business situations, as they are easier to sketch out than general journals.

A prepaid account is an account that shows the balance of money we have paid in advance of an expense being incurred. Prepaid accounts are assets.

A T-account is a visual depiction of the activity in an account. Entries made on the left side of the T-account represent debits, while entries on the right side represent credits. The ending account balance is the total net combined debits and credits for that account.

Asset accounts, dividend accounts, and expense accounts are increased with a debit. (Also, contra-liability accounts, contra-equity accounts, and contra-revenue accounts are increased with a debit.)

Normal balance refers to the expected ending balance for an account, based on the way that the account balance increases (either debit or credit.)

The purpose of the trial balance is to recap the account balances, to ensure that debits equal credits. The trial balance is used to prepare the financial statements, in this order: Income Statement, Retained Earnings Statement, and Balance Sheet.