Ch. 3 - The Accounting Cycle: End of the Period - Learning Objective

LO3-3 Demonstrate the purposes and recording of adjusting entries.

Adjusting entries are a necessary part of accrual-basis accounting. They help to update the balances of assets, liabilities, revenues, and expenses at the end of the accounting period for transactions that have occurred but have not yet been recorded. Adjusting entries are needed when cash flows or obligations occur before the earnings-related activity (repayment)or when cash flows occur after the earnings-related activity (accrual). Adjusting entries are unnecessary in two cases: (1) for transactions that do not involve revenue or expense activities and (2) for transactions that result in revenues or expenses being recorded at the same time as the cash flow.

LO 3-7 Post closing entries and prepare a post0closing trial balance.

After we post the closing entries to the general ledger, the balance of Retained Earnings equals the amount shown in the balance sheet. The balances of all revenue, expense, and dividend accounts are zero at that point.

LO 3-6 Demonstrate the purposes and recording of closing entries.

Closing entries serve two purposes: (1) to transfer the balances of temporary accounts (revenues, expenses, and dividends) to the Retained Earnings account, and (2) to reduce the balances of theses temporary accounts to zero to prepare them for measuring activity in the next period. Closing entries increase related earnings by the amount of revenues for the period and decrease retained earnings by the amount of expenses and dividends for the period.

LO3-2 Distinguish accrual-basis and cash-basis accounting.

The difference between accrual-basis accounting and cash-basis accounting is timing. Under accrual-basis accounting, we record revenues when we provide goods and services to customers, and we record expenses with the revenue they help to generate. Under cash-basis accounting, we record revenues when we receive cash, and we record expenses when we pay cash. Cash-basis accounting is not allowed for financial reporting purposes for most major companies.

LO3-1 Understand when revenues and expenses are recorded.

The revenue recognition principle states that we record revenue in the period in which we provide goods and services to customers, not necessarily in the period in which we receive cash. Most expenses are recorded in the same period as the revenues they help to generate. Other expenses indirectly related to producing revenues are recorded in the period they occur.

LO3-4 Post adjusting entries and prepare an adjusted trial balance.

We post adjusting entries to the general ledger to update the account balances. An adjusted trial balance is a list of all accounts and their balances at a particular date, after we have updated account balances for adjusting entries.

LO3-5 Prepare financial statements using the adjusted trial balance.

We prepare the income statement, statement of stockholders' equity, and balance sheet from the adjusted trial balance. The income statement provides a measure of net income (profitability), calculated as revenues minus expenses. The balance sheet demonstrates that assets equal liabilities plus stockholders' equity (the basis accounting equation).