Explain Nominal Accounts, Perpetual System, and Adjustments
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1. Why are revenue and expense accounts called temporary or nominal accounts? please explain.
2. Under a perpetual system, what is the purpose of the cost of goods sold account?
3. What are adjusting entries and why are they necessary?
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The cited solution devotes a full paragraph in response to each of the three questions in the problem followed by some examples of adjusting entries with explanations.
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1. Revenue and expense accounts are called temporary or nominal because they are 'closed' once a year. Closed means that the account balances are transferred to an equity account (Retained earnings for a corporation, Owner's equity for a sole proprietorship). So the account balances are brought to zero and then the new year begins. Amounts are accumulated again. You might ask why the balance sheet accounts aren't also closed. That is because the balance sheet is a listing of what a company owned and owes, whereas the revenue and expense accounts show the earnings and expenses for a period of time, usually one year. Then you might ask why we clean them up and start over. The business world wants to know 'how are we doing' and a very ...
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