🚀 How to Use Pro Tips
Welcome to Lee's Exam Pro Tips
Here, you'll find an array of tips to help you ace any accounting exam. Each tip is organized by chapter for easy navigation and designed to clarify confusions, introduce shortcuts, and guide you towards exam success.
You can deep-dive into the entire collection for comprehensive prep or cherry-pick tips to target your specific challenges.
Your partner in exam domination, - Lee 📨 lee@surviveaccounting.com
PS — send me an email to introduce yourself or ask any questions! (I personally reply to every email.)
📖 Chapter 1
- Approach with an Internal Lens:
- Always consider how a transaction affects the company's financial position. Remember, the company and its owner are separate entities; the impact on one might not mirror the other.
- The Business Entity Principle:
- This concept reinforces the need for adopting the company's perspective. The Business Entity Principle, one of the fundamental concepts in accounting, emphasizes that a business is separate and distinct from its owners.
- Therefore, financial transactions and decisions should be analyzed based on their impact on the company, rather than how they affect the owner.
📖 Chapter 2
- Assets works like (+/-)
- L + E both work like (-/+)
Therefore, remember that Assets always behave oppositely to Liabilities and Equity. Since Assets work on a (+/-) basis, then Liabilities and Equity will be (-/+).
- This flip across the equal sign of A = L + E is a great visual memory aid!
Assets = Liabilities + Equity Revenues / Expenses (+/-) (-/+) (-/+) (-/+) (+/-)
- Revenues and Equity, both operating on a (-/+) basis, share a logical connection.
- Generating revenue increases a company's value, which is reflected in its equity.
- Therefore, if increasing revenue boosts equity, it makes sense that they both function similarly, utilizing a (-/+) mechanism.
- To summarize, memorize this: revenue (-/+) and equity (-/+) always work the same when it comes to debits and credits!
Assets = Liabilities + Equity Revenues / Expenses (+/-) (-/+) (-/+) (-/+) (+/-)
- There’s a reason that expenses and equity work opposite of eachother.
- Expenses are our “costs.” Doesn’t it make sense that costs reduce a company's equity, or “value”?
- Therefore, since incurring expenses decreases equity, it's logical that they operate inversely — Expenses being (+/-) and Equity being (-/+).
- Remember this key point: expenses (+/-) and equity (-/+) work oppositely when it comes to debits and credits.
- Expenses and Assets, both following a (+/-) pattern, are intrinsically linked.
- For instance, expenses will often orginate from our assets —particularly when these assets are consumed or utilized.
- Let's consider some examples to illustrate this relationship:
- A building (an asset) depreciates over time, turning into a depreciation expense.
- Inventory (an asset) transforms into the Cost of Goods Sold (an expense) once sold.
- Prepaid Rent (an asset) turns into Rent Expense as the lease term elapses.
- Prepaid Insurance (an asset) becomes Insurance Expense as our coverage expires.
- Accounts Receivable (an asset) morphs into Bad Debt Expense when a customer defaults on payment.
- Many other examples exist!
- Assets can be thought of as 'pending' expenses that will be utilized or 'expensed' eventually.
- Conversely, sometimes, expenses can best be viewed as assets that have been consumed. This cyclical relationship suggests that they're essentially the same thing at different stages.
- Given this, it logically follows that assets and expenses operate identically regarding debits and credits, adhering to the (+/-) pattern.
- To summarize, memorize this: Assets (+/-) and Expenses (+/-) always work the same when it comes to debits and credits!
- This is not true! Whether a debit or credit increases or decreases an account depends on the type of account.
- Again, this is false! Debits and credits are used to record all types of transactions, not just receiving or giving things away.
- This is a very common misunderstanding! While these terms share names with common banking tools, their usage in accounting is completely different.
These misconceptions can seriously hinder your understanding of accounting. Unlearn them now!
- For transactions involving cash, it boils down to only two possibilities: paying cash or receiving cash.
⚔️ Discover your secret weapon below ⚔️
- Obviously, every time you pay cash — your cash balance decreases!
- Since cash is an asset (+/-) and all assets decrease with a credit…
- you must credit cash for all journal entries involving cash payments.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) payment of cash, that transactions journal entry will ALWAYS include a CREDIT to cash.
- At last, we have something consistent to rely on!
- Conversely, every time you receive cash — your cash balance increases!
- Since cash is an asset (+/-) and all assets increase with a debit…
- you must debit cash for all journal entries involving receiving cash.
- Key word = MUST. This means, any time you’re reviewing a transaction that involves the immediate (not future) receipt of cash, that transactions journal entry will ALWAYS include a DEBIT to cash.
- At last, we have something consistent to rely on!
Remember this "Cheat Code" to confidently handle cash transactions. It will make some journal entries on exams so easy — you’ll literally feel like you're cheating.
- Rather than searching for both sides of the transaction, you already have one side resolved. This allows you to concentrate on determining the other side of the journal entry with more precision.
- For example, let’s say you encounter an exam question like this.
- When you read “paid $200 cash,” you can immediately rest assured that the journal entry will 100% include a CREDIT to cash.
- Knowing this, you can then focus all of your energy on determining the correct debit entry!
- Another example:
- When you read “received $200 cash,” you can immediately rest assured that the journal entry will 100% include a DEBIT to cash.
- Knowing this, you can then focus all of your energy on determining the correct credit entry!
- Lastly, The Cash Cheat Code can be a valuable “process of elimination” tool during multiple choice exam questions.
- For instance, if a question involves a cash payment transaction — any option that doesn't credit cash is automatically incorrect! See a quick example below.
- Accounting is often mislabled as a number-intensive course with complex math. However, this isn't true. The math involved is simple—just basic addition, subtraction, and a sprinkle of middle school algebra. So, don’t worry about the math!
- The real challenge lies not in crunching numbers but in deciphering word problems that describe business transactions. These are your real tests. Remember, accounting is fundamentally the language of business. Without the ability to understand and interpret this language, you're setting yourself up for trouble as these word problems can become increasingly complex.
- Knowing that this course is mostly about comprehending word problems that contain simple numbers, rather than being strictly math-oriented, can make all the difference. My aim in Survive Accounting is to help you ace these word problems by mastering their interpretation, ultimately making them significantly more manageable for you.
- How can we start to master deciphering these word problems? Begin by recognizing the underlying meaning of commonly used words and phrases in these problems.
- Below are some examples to get you started.
- Trigger words indicating the type of account:
- Any account with "Receivable" always refers to an asset account.
- Any account with "Prepaid" always refers to an asset account.
- Any account with "Payable" always refers to a liability account.
- Any account "Earned" always refers to a revenue account.
- For a deeper understanding of why these trigger words make sense, refer to the section “Memorizing ALL of the accounts within each of the five types (A = L + E, Revenues, Expenses)” provided on the left.
- Trigger words indicating the nature of a transaction:
- Phrases like performed, delivered, rendered, or completed services are clear signs of earned revenue from services.
- Phrases like sold, delivered, or shipped goods always indicates earned revenue from selling inventory.
- Phrases like on credit or on account suggest that cash payment or receipt is deferred to later, often involving accounts receivable or payable.
- Phrases such as received cash in advance or received cash upfront typically signify Unearned Revenue transactions, where we’ve received cash in advance for services to be provided later.
- Numerous other trigger words exist, specific to certain types of problems and later chapters. My mission with Survive Accounting is to familiarize you with all of them. Your professor may not disclose these (as it would make the course too easy!), but spotting them can provide you with a significant edge.
- In Accounting, word problems are often designed to be intentionally tricky, making you second-guess your answers. While not all professors follow this approach, many do.
- Take, for instance, my own experience with Dr. D at Ole Miss. She openly admitted to laying 'traps' in her tests, relishing the thought of us getting 'snared like rabbits' by her exam questions (these were her actual words!)
- She was an exceptional teacher, but her exams were notoriously tricky. This experience sparked my philosophy of "outsmarting your professor.”
- My advice to you is to embrace this complexity. Learn to identify these tricks and traps. There's no feeling quite like spotting these tricks during your exam, dodging them, and effectively outmaneuvering your professor who is trying to trick you!
- While these tricks may trip up your classmates, they won't get past you. With Survive Accounting, my aim is not only to teach you the course content but to also help you recognize and navigate these tricky problems.
- For a more in-depth understanding of this concept, I strongly urge you to review the "Common Mistakes" section associated with each journal entry example provided below.
- Recording journal entries often leaves students feeling overwhelmed. In my past role as a tutor, a common complaint I encountered was, "how do I know which account to use?"
- This reaction indicates an expectation of being told directly which accounts are needed in a journal entry. However, such explicit guidance is rarely, if ever, provided in an accounting exam. Unfortunately, in this course, you’re on your own!
- This calls for you to become your own investigator: dive into the word problem, decipher the transaction involved, and autonomously decide on the appropriate accounts for your journal entry.
- This degree of self-reliance is a part of what makes accounting appear intimidating to many. Unlike other subjects where information is handed on a platter, accounting demands resourcefulness. Often, accounting is the first course students ever take that requires this level of independent problem-solving ability.
- Ask yourself. Do you really want all the answers handed to you? Embrace the challenge! My mission with Survive Accounting is to nurture your independence, equipping you to discover answers on your own. The unique gratification and confidence boost from successfully solving problems independently is an experience like no other.
- This feeling of self-accomplishment in problem-solving is a major reason why I enjoy teaching accounting—my goal is to inspire the same feeling in you.
- Given that you won't be spoonfed any answers or receive much guidance, how can you independently solve these problems? What's the process?
- Successful accountants approach word problems about business transactions with curiosity, intellectual skepticism, and an investigative mindset. It's all about asking the right questions!
- Let's use an example. Suppose you encounter this transaction on an exam and you're trying to determine the necessary accounts for the journal entry.
Here's a logical sequence of questions to ask yourself to help solve the journal entry above:
- We're providing services to a customer and have immediately received cash in return.
- Cash, an asset account, is involved. Services have been rendered, implying revenue has been earned, hence a revenue account such as Fees Earned is affected too.
- Since we received cash, our cash balance goes up. As cash is an asset, it's logical to increase this account. Keeping in mind that all assets operate like (+/-), it makes sense to debit Cash in the journal entry.
- Revenue was earned, so we need to increase Fees Earned (a revenue account) to acknowledge the earned revenue. Considering that revenue accounts function like (-/+), it makes sense to credit Fees Earned in the journal entry.
- What’s happening in this transaction?
- What’s types of accounts are affected by it?
- Which individual accounts within those types need to be included?
- What's increasing/decreasing as a result of the transaction?
- Therefore, do these accounts need to be debited or credited to reflect that?
- Lastly, what amount accurately captures the reality of this transaction?
I know it might seem challenging, but with practice, this process will become second nature. My mission with Survive Accounting is to help you think independently, find answers autonomously, and resist the idea that you should be spoonfed answers. While some college courses may spoonfeed you in this way, the real world doesn’t. Embrace the challenge now!
- To excel in this course, mastering the interpretation of word problems about business transactions and their impacts on your accounting system is key.
- A helpful strategy is to imagine these transactions are happening within your own business. They're affecting your accounting. Adopting this internal perspective is crucial as it illuminates the effects of transactions more clearly.
- For example:
- When a problem presents a company paying cash for supplies — envision this happening in your company. What does this mean?
- If a problem describes a company performing services for a customer on credit, meaning the customer will pay us later — put yourself in the shoes of that business owner. What does this mean?
- If a scenario details a company purchasing a prepaid insurance policy — think of it as your company's transaction. What does this mean?
- Adopting this kind of imaginative thinking and perspective not only makes learning accounting more engaging, but it also provides a clearer mental picture of word problems—which ultimately contributes to better performance on exams.
- Awareness of the frequent mistakes made by many students can steer you clear of the same traps in your exam—significantly improving your likelihood of success.
- Therefore, understand that acing accounting exams isn't just about memorizing the right journal entries; it's about understanding why they are correct and why others are not.
- For a more in-depth understanding of this concept, I strongly urge you to review the "Common Mistakes" section associated with each journal entry example provided below.
- Attempting to memorize journal entries is, quite frankly, an ineffective strategy. The sheer volume of possible entries is too great.
- The better strategy? Remember that journal entries fundamentally serve to record and reflect actual business transactions. Therefore, a powerful technique is to immerse yourself in the transactions, developing curiosity about how they should be documented.
- Strive to understand why a specific journal entry is accurate, which effectively requires adopting the mindset of a businessperson. This sounds more fun than just memorizing, right?
- To put it simply, excelling in accounting exams requires more than just building your accounting knowledge. It's also about building your business acumen and developing a deeper understanding of transactions.
- My success in learning accounting was largely attributed to my intense curiosity about the inner workings of businesses. Upon starting my first accounting course, I was brimming with enthusiasm to master the language of business. This curiosity and eagerness acted as a catalyst in my understanding of the subject matter, leading to my stellar performance in exams.
- It's important to remember that accounting isn't merely about crunching numbers—it's a core component of business education. Through Survive Accounting, my goal is to share this passion and drive on to you, inspiring you to foster your own.
- So, if you're fascinated by the world of business, like I am, you've chosen the perfect discipline to learn more about its complex inner workings!
- Instead of the traditional approach of identifying debited accounts first, challenge this habit. If you already know which account is credited, begin with that instead! This can make the process more effective and intuitive.
- Take, for example, the following transaction:
- Using your knowledge of the Cash Cheat Code, you know for certain that cash will be credited. So, jot that down first! This allows you to concentrate your attention on identifying the correct debit.
- This method, where you start with known information and proceed to solve for the unknown, can significantly streamline the process of recording journal entries. Plus, it builds confidence as it reduces the need to find both debit and credit at the same time.
- Students who try to memorize journal entries in their entirety often face difficulty due to the sheer volume of information they attempt to absorb all at once.
- Consider that a single journal entry may involve several debits or credits. If your study approach is pure memorization, you'd find yourself struggling to remember a multitude of debited and credited accounts, which can lead to a frustrating, ineffective study experience.
- Instead, consider recording journal entries as a step-by-step process. Begin by contemplating how you would initially structure the problem, then progressively unravel each element of the journal entry, step by step. (In future chapters, I will show you the simplest steps to setup journal entry problems on your exams, so stay tuned!)
- Memorizing the steps required to record a journal entry is significantly easier than trying to remember the journal entry in its entirety. Why so?
- As we'll explore, many journal entries are conditional on the specific wording of the problem. Specific words might necessitate alterations to a journal entry, posing a risk for students who've memorized only a single version of the entry.
- On the other hand, Survive Accounting students who've committed to memory the steps involved in recording a journal entry can correctly identify the answer, no matter how the problem is phrased!
- Time and again, I've observed students—who had not yet discovered Survive Accounting—shocked by their initial test grades: a D or even an F. For many, it’s an unprecedented low point in their academic journey, the first bad test grade they've ever received. But why does this occur?
- The issue, I believe, is that students often don't practice enough. They might read (or even skim) their textbook, take notes in class, or use an online quizlet—which often is just the textbook regurgitated—and then, they think they're ready for the exam.
- WRONG! This will not prepare you in any meaningful way. Avoid falling into this trap!
- Sadly, even the most dedicated students who spend countless hours studying can still fall short in exams because they never engaged deeply with practice problems. (Often, their first hands-on encounter with an accounting problem comes when they're already sitting for the exam! Does this seem like a good strategy to you?)
- The solution? You can do the exact opposite of this. Study using my extensive collection of practice exams and solutions to strengthen your accounting muscle and boost your confidence in tackling these challenging problems
- It's just like hitting the gym. The more ‘reps’ you do—practicing the recording of journal entries—the more confident you'll become. So, while your peers may be shell-shocked by their unexpectedly low grades, you can enjoy a quiet sense of satisfaction knowing you've aced the exam due to your diligent practice.
- Moreover, this ‘put in the reps’ approach to practice serves as an effective remedy for those who struggle with test-taking anxiety. Such disciplined preparation fosters a level of confidence so immense—it will often alleviate feelings of anxiety during your exam.
- Many courses might allow you to successfully cram the night before, or even the day of, the exam. However, Accounting is definitively NOT one of those subjects. Trust me, I’ve mentored thousands of students in this course, and I’ve seen the damage. Do not ignore this advice or think you're the exception.
- Instead, when planning your study time, be sure to allow sufficient time for the material to settle into your subconscious mind. This is crucial, especially if you've missed lectures, skipped homework assignments, or fallen behind on the material.
- My suggestion is to allocate at least 2-3 days—meaning, if your exam is on Friday, the bulk of your studying should be done by Tuesday. Then, use Wednesday through Friday to revisit and refresh the material you've already learned.
- If you attempt to learn entirely new accounting concepts the day before your exam, they won't have the chance to fully take root in your mind. No matter how hard you cram, you'll still enter your test feeling like a deer in headlights.
- Stay ahead of the curve and begin your practice early, giving yourself the chance to "sleep on" the material. By doing so, you'll outperform your peers who make the mistake of resorting to last-minute cramming.
- The spacing effect refers to the finding that spacing out learning or study sessions over time leads to better long-term retention and learning compared to cramming or massed practice. Research studies have demonstrated this effect, such as the influential study by Bahrick et al. (1993) which showed that spaced practice resulted in superior memory recall compared to massed practice.
- Psychologically, the spacing effect is related to distributed practice, allowing for effective encoding and consolidation of information in memory. Spacing out learning sessions provides time for the brain to process and reinforce learned material, enhancing memory consolidation.
- Physiologically, the spacing effect is associated with synaptic plasticity, the ability of synapses to change and strengthen with repeated stimulation. Spaced learning allows for the consolidation of synaptic changes associated with memory formation, resulting in stronger and more durable memory traces.
- In the context of Tip #12, understanding the spacing effect suggests that studying and reviewing accounting material over time with spaced intervals promotes better retention. Allowing information to "marinate" in the mind and incorporating sufficient sleep between study sessions enhances memory consolidation and improves learning outcomes.
📌 What is Unearned Revenue? This is for cash received in advance for products or services yet to be provided. It is considered a liability because, despite already being paid upfront, the company still owes the goods or services.
- You might be asking yourself, 'How can receiving cash become a liability, suggesting we owe something?' Though this seems counterintuitive, understanding the revenue recognition principle clarifies it.
- The principle asserts that revenue is only recognized when earned, i.e., when the service is delivered. Therefore, money received for a service not yet provided is 'unearned revenue' until we actually deliver the service.
- Consider this another way: you've received upfront cash, but the service remains undelivered. What if the service isn't provided, or the customer cancels the contract?
- In that case, you might need to refund the money! Given these uncertainties, can we truly claim we've 'earned' that cash?
- Isn't it logical to set up a liability account to earmark these funds until we genuinely earn them?
- That's exactly our strategy. At the year end, we'll evaluate how much of our unearned revenue has been earned (i.e., the proportion of the service actually delivered and what remains outstanding).
- Following this, we'll record an adjusting entry to effectively convert unearned revenue into earned revenue.
- We’ll expand much deeper on Unearned Revenue adjusting entries in Chapter 3. With practice, it'll become second nature to you.
⚠️ Be extremely careful not to debit Supplies Expense when simply purchasing Supplies!
❌ Incorrect Example
On January 5th, Survive Company purchases $1000 worth of supplies on credit.
Supplies Expense 1,000
Cash 1,000
Your exam will attempt to trick you into doing this. It is incorrect!
- Purchasing supplies does not mean we should debit an expense account. Why not? Well, simply purchasing supplies doesn't mean we've used any of them!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On January 5th, Survive Company purchases $1000 worth of supplies on credit. Supplies 1,000 Cash 1,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
- It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
- So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
⚠️ Be extremely careful not to debit Insurance Expense when prepaying for insurance!
❌ Incorrect Example
On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy.
Insurance Expense 12,000
Cash 12,000
Your exam will attempt to trick you into doing this. It is incorrect!
- Prepaying for insurance does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid insurance doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On July 1st, 2023, Survive Company pays $12,000 in cash for a 12-month insurance policy. Prepaid Insurance 12,000 Cash 12,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
- It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
- Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
- Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
- The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
- So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
Hey there! If you're reading these Pro Tips, I want you to know that I'm genuinely stoked you're here. With some hard work — I wholeheartedly believe you're going to ace your exams. Your partner in exam domination, - Lee lee@survivestudios.com (I'd love to hear from you! Drop me a line or introduce yourself via email.)
⚠️ Be extremely careful NOT to debit Rent Expense when prepaying for rent! ❌ Incorrect Example: On August 31st, 2023, Survive Company pays $24,000 in cash for a 12-month lease on a building.
Rent Expense 24,000
Cash 24,000
Your exam will attempt to trick you into doing this. It is incorrect!
- Prepaying for rent does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid rent doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
✅ Correct Example On August 31st, 2023, Survive Company pays $24,000 in cash for a 12-month lease on a building. The journal entry is: Prepaid Rent 24,000 Cash 24,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
⚠️ Be extremely careful NOT to debit Advertising Expense when prepaying for advertising! ❌ Incorrect Example On January 1st, Survive Company pays $180,000 in cash for a 36-month advertising contract. The contract will be delivered evenly each month.
Advert. Expense 180,000
Cash 180,000
Your exam will attempt to trick you into doing this, especially on multiple choice. It is incorrect!
- Prepaying for advertising does not mean we should debit an expense account. Why not? Well, simply purchasing prepaid advertising doesn't mean we've used any of it!
- Recall the expense recognition principle: we only record expenses when they're consumed or used (the true 'cost'), not just when we purchase or pay for them.
Remember, the correct entry is: ✅ Correct Example On January 1st, Survive Company pays $180,000 in cash for a 36-month advertising contract. The contract will be delivered evenly each month. Prepaid Advertising 180,000 Cash 180,000
Confused? I’ve included my Pro Tip for Understanding Expenses below, if you need a refresher.
It's a common misconception to associate expenses solely with the outflow of cash. That's not always accurate!
Understanding the timing of expense recognition is crucial for interpreting its impact on financial statements. This is where the matching principle comes in handy: expenses are recognized when the resources or services are used to generate revenue, not necessarily when cash is paid.
Let's consider an example. If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
The expense hits our books only when we actually use the supplies in our operations. The act of buying the supplies doesn't equate to an expense—it's the usage that counts!
So, remember: expenses aren't about cash payments but about resource consumption. This understanding will be particularly useful in Chapter 3, where we delve into adjusting journal entries. So keep practicing!
⚠️ Be extremely careful not to debit Dividends Expense when paying Dividends!
❌ Incorrect Example
On Dec 31st, Survive Company pays $220,000 in cash dividends to it’s owners and investors.
Dividends Expense 220,000
Cash 220,000
Your exam will attempt to trick you into doing this. It is incorrect! The idea of "Dividends Expense" does not exist in accounting!
- Dividends aren't expenses or “costs” incurred during revenue generation. They're separate from business operations.
- Dividends are instead a method for owners and investors to "withdraw" retained earnings from the business (which is why Dividends are sometimes known as “drawings”).
- Dividends are similar to expenses in that they both reduce equity, but they do so for different reasons.
- Consider this perspective:
- Expenses decrease equity due to their negative effect on Net Income, which reduces Retained Earnings. This happens before the distribution of a dividend.
- Dividends, on the other hand, reduce equity after net income has been consolidated into retained earnings. Thus, it’s not an expense—it's a deduction from previously earned net income!
- Per the expense recognition principle, expenses must be reported in the same period they’re incurred. So, recording Dividends as an expense doesn't comply with this principle.
- Instead, be sure to record Dividends as a contra equity account.
✅ Correct Example On Dec 31st, Survive Company pays $220,000 in cash dividends to it’s owners and investors. Dividends 220,000 Cash 220,000
🚧 Chapter 3
This resource is currently under development. Ready to study Chapter 3 now? Survive Plan subscribers can currently access all archived videos and homework solutions for Chapter 3 — more than enough to prepare you for this chapter.
🚧 Chapter 4
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🚧 Chapter 5
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🚧 Chapter 6
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🚧 Chapter 7
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🚧 Chapter 8
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🚧 Chapter 9
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🚧 Chapter 10
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🚧 Chapter 11
This resource is currently under development.
Note: These are listed in the order they appear from each chapter’s cheat sheets. Some apply universally, while others are more chapter-specific.
