Accounting Chapter 4

Expense Recognition Principle

(Matching Principle) - requires that efforts (expenses) be matched with accomplishments (revenues) - you are matching revenue and expenses in the same period in which they both continue to. - Matching Principle adheres to Accrued Accounting.

Closing Entries

1. Close revenues into Income Summary 2. Close expenses into Income Summary 3. Close Income Summary into Retained Earnings 4. Close Dividends into Retained Earnings

Unearned Revenues (Deferrals)

Cash received and recorded as liabilities before the revenue is earned - you receive payment in advance for product or service - cannot record as revenue until earned so originally you put money to Unearned revenue as credit and debit cash - once you have earned the sale (revenue) you move from Unearned revenue by debiting and move to Revenue by crediting ... by not doing an adjusting entry when needed the liabilities would be overstates and the revenue would be understated. Debit Unearned Revenue Credit Revenue

Periodicity Assumption

Accounting divides the economic life of a business into artificial time periods - Accounting time periods are generally a month, a quarter, or a year.

Reporting

Determining the amount of revenues and expenses to report in a given accounting period can be difficult - Proper reporting requires an understanding of the nature of the company's business - principles are used as guidelines.

Accrued Expenses (Accruals)

Expenses incurred but not yet paid or recorded at the statement date - interest, taxes, and salaries are common examples ... by not doing these adjusting entries when needed the expenses would be understated and the liabilities would be understated. Debit Interest Expense Credit Interest Payable Debit Wages Expense Credit Wages Payable

Prepaid Expenses (Deferrals)

Expenses paid in cash and recorded as assets until they are used or consumed - prepaid expenses are costs that expire with the passage of time (rent, insurance) or through use (supplies) ... by not doing an adjusting entry when needed the assets would be overstated and the expenses would be understated. Debit Supplies Expense Credit Supplies Debit Insurance Expense Credit Prepaid Insurance

Adjusting Entries

Need to ensure the revenue recognition and matching principles are followed. Required every time a company prepares financial statements. Will always include one income statement account and one balance sheet account. Classified as either deferral or accruals.

Accrued Revenues (Accruals)

Revenues earned but not yet recorded - same entry you do when recording a sale on account ... by not doing this entry when needed the Assets would be understates and the revenues would be understated. Debit Accounts Receivable Credit Revenue

Cash Basis of Accounting

You recognize (record) when cash is received or paid out - cash basis does not satisfy the requirements of GAAP whereas accrual accounting does - net income is easy to manipulate with this method ( you could hold on to cash and not record it or not pay a bill until you're ready to because you don't want the revenue or expense to show up in the income statement).

Expense Accounts

You want to zero out all of the expense accounts to do so you have to credit each accounts for the balance in the account because expenses have a normal debit balance.

Revenue Accounts

You want to zero out all of the revenue accounts to do so you have to debit each account for the balance in the account because revenues have a normal credit balance.

Zeroing out Dividends

You would have to credit the account for the balance in the account because dividends have a normal credit balance.

Zeroing out the Income Summary Account

Once you have posted all the closing entries from the revenues and expenses you calculate the balance of the Income Summary and if it has a credit balance you would debit it to put it to zero and if it has a debit balance you would credit it to put it to zero - because you have just closed all the revenue and expense accounts into income summary the balance in the income summary account should be the net income or net loss for the period just like on the income statement.

Adjusted Trial Balance

After all accounts have been updated with adjusting entries. You do this to prove out debits and credits again.

Trial Balance

May not contain up-to-date and complete data for several reasons: 1. Some events are not recorded daily because it is not efficient to do so (like depreciation and accrued interest) 2. Some costs are not recorded during the accounting period because these costs expire with the passage of time rather than as a result of recurring daily transactions (like prepaid expenses) 3. Some items may be unrecorded - just not recorded yet (like accrued revenues and accrued expenses)

Revenue Recognition Principle

Requires that revenue be recognized in the accounting period in which it is earned - so a service company recognizes (records) revenue when the services are performed.

Temporary Accounts

Revenues, expenses, income summary and dividends; only can do closing entries on temporary accounts.

After Adjusting Entries are Recorded In The Journal

They must be posted into the ledger accounts just like regular journal entries.

Post-Closing Trial Balance

To prove out the debits and credits again. Since you've already zeroed out all the temporary accounts this will only have balance sheet, which are permanent accounts, on it.

Accrual Basis of Accounting

Transactions that change a company's financial statements are recorded in the periods in which the events occur, even if cash is not exchanged. Recognize revenues when earned (you earn it when you actually provide the customer with the service or product you are selling them) and expenses when incurred (something you acquire and are now liable for or responsible for). Accrued accounting requires accountants to adhere to the revenue recognition principle and the matching principle.