Chapter 4: Accrual Accounting Concepts (ENTRIES and vocab)

Every Adjusting Entry will include

One Income Statement and One Balance Sheet Account

Time periods for accounting?

- A month - A quater - A year

Expense recognition principle (matching principle)

The principle that matches expenses with revenues in the period when the company makes efforts to generate those revenues.

Depreciation

The process of allocating the cost of an asset to expense over its useful life.

Accruals

Accrued Revenues or Accrued Expenses

Two categories that Adjusting Entries be classified into

1) Deferrals 2) Accruals

Required steps in the Accounting Cycle

1. Analyze business transactions 2. Journalize the transactions 3. Post to ledger accounts. 4. Prepare a trial balance. 5. Journalize and post adjusting entries: Deferrals/Accruals 6. Prepare an adjusted trial balance. 7. Prepare financial statements (income statement, retained earnings statement, balance sheet) 8. Journalize and post closing entries. 9. Prepare a post-closing trial balance.

Adjusted trial balance

A list of accounts and their balances after all adjustments have been made.

Post-closing trial balance

A list of permanent accounts and their balances after a company has journalized and posted closing entries.

Worksheet

A multiple-column form that companies may use in the adjustment process and in preparing financial statements.

Income Summary

A temporary account used in closing revenue and expense accounts.

Cash-basis accounting

Accounting basis in which a company records revenue only when it receives cash and an expense only when it pays cash.

Accrual-basis accounting

Accounting basis in which companies record, in the periods in which the events occur, transactions that change a company's financial statements, even if cash was not exchanged.

A requirement of the Generally Accepted Accounting Principles [GAAP]

Accrual Basis Accounting

This is required every time a company prepares financial statements

Adjusting Entries

Contra asset account

An account that is offset against an asset account on the balance sheet.

Fiscal year

An accounting period that is one year long.

Describe the nature and purpose of the adjusted trial balance.

An adjusted trial balance is a trial balance that shows the balances of all accounts, including those that have been adjusted, at the end of an accounting period. The purpose of an adjusted trial balance is to show the effects of all financial events that have occurred during the accounting period.

Periodicity assumption

An assumption that the economic life of a business can be divided into artificial time periods.

Reversing entry

An entry made at the beginning of the next accounting period; the exact opposite of the adjusting entry made in the previous period.

When are supplies expense recognized?

At the end of the accounting period

When is revenue considered to be earned in a Service Business?

At the time the service is performed

The key words in Deferral

BEFORE Assets are used or consumed BEFORE Revenue is earned

Permanent accounts

Balance sheet accounts whose balances are carried forward to the next accounting period. all asset accounts all liability accounts stockholders' equity accounts

Unearned revenues

Cash received and a liability recorded before services are performed.

Unearned Revenues

Cash received and recorded as liabilities before revenue is earned

Explain why adjusting entries are needed, and identify the major types of adjusting entries.

Companies make adjusting entries at the end of an accounting period. These entries ensure that companies record revenues in the period in which the performance obligation is satisfied and that companies recognize expenses in the period in which they are incurred. The major types of adjusting entries are prepaid expenses, unearned revenues, accrued revenues, and accrued expenses.

(Adjusting Entries for Accruals) To record the adjustment of an accrued revenue (to record the total revenue for services performed during that month or period)

Dr. Accounts Receivable Cr. Service Revenue

To record cash collected on account on a receivable

Dr. Cash Cr. Accounts Receivable

(Adjusting Entries for Deferrals) To record monthly depreciation

Dr. Depreciation Expense Cr. Accumulated Depreciation - Equipment

(Adjusting Entries for Deferrals) To record the expiration of a prepaid expense

Dr. Expense Account Cr. Asset Account

(Adjusting Entries for Deferrals) To record insurance expired or "used" during the period

Dr. Insurance Expense Cr. Prepaid Insurance

(Adjusting Entries for Accruals) To record accrued interest on notes payable

Dr. Interest Expense Cr. Interest Payable

(Adjusting Entries for Accruals) To record accrued salaries

Dr. Salaries and Wages Expense Cr. Salaries and Wages Payable

To record payment of accrued salaries

Dr. Salaries and Wages Payable Dr. Salaries and Wages Expense Cr. Cash

(Adjusting Entries for Deferrals) To record supplies used during the accounting period

Dr. Supplies Expense Cr. Supplies

(Adjusting Entries for Deferrals) To record revenue for services performed previously booked as unearned

Dr. Unearned Revenue Account Cr. Revenue Account Dr. Unearned Service Revenue Cr. Service Revenue

When are Adjusting Entries required?

Each time a Financial Statement is prepared

The dictation of Matching Principle

Efforts [expenses] be matched with accomplishments [revenues]

Closing entries

Entries at the end of an accounting period to transfer the balances of temporary accounts to a permanent stockholders' equity account, Retained Earnings.

Adjusting entries

Entries made at the end of an accounting period to ensure that the revenue recognition and expense recognition principles are followed.

What are Adjusting Entries?

Entries that may or may not be "source documents" such as invoices or sales receipts

Accrued Expenses

Expenses incurred but not yet paid in cash or recorded

Accrued expenses

Expenses incurred but not yet paid in cash or recorded.

Prepaid Expenses

Expenses paid in cash and recorded as assets before they are used or consumed Prepaid expenses expire with the passage of time or through use and consumption

Prepaid expenses (prepayments)

Expenses paid in cash before they are used or consumed.

Quality of earnings

Indicates the level of full and transparent information that a company provides to users of its financial statements.

The reason why Cash Basis Accounting Measures is sometimes avoided

It result in misleading financial information because income would be misstated for the years available.

The key words in Accrual

NOT YET received in cash or recorded NOT YET paid in cash or recorded

Understand the causes of differences between net income and net cash provided by operating activities.

Net income is based on accrual accounting, which relies on the adjustment process. Net cash provided by operating activities is determined by adding cash received from operating the business and subtracting cash expended during operations.

Is Cash- Basis accounting in accordance with the GAAP?

No

Explain the purpose of closing entries.

One purpose of closing entries is to transfer net income or net loss for the period to Retained Earnings. A second purpose is to "zero-out" all temporary accounts (revenue accounts, expense accounts, and Dividends) so that they start each new period with a zero balance. To accomplish this, companies "close" all temporary accounts at the end of an accounting period. They make separate entries to close revenues and expenses to Income Summary, Income Summary to Retained Earnings, and Dividends to Retained Earnings. Only temporary accounts are closed.

Deferrals

Prepaid expenses or Unearned Revenues

Temporary accounts

Revenue, expense, and dividend accounts whose balances a company transfers to Retained Earnings at the end of an accounting period. all revenue accounts all expense accounts dividends

Accrued Revenues

Revenues earned but not year received in cash or recorded

Accrued revenues

Revenues for services performed but not yet received in cash or recorded.

The starting place for adjusting entries

The Trial Balance

Book value

The difference between the cost of a depreciable asset and its related accumulated depreciation.

Useful life

The length of service of a productive asset.

Earnings management

The planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income.

Revenue recognition principle

The principle that companies recognize revenue in the accounting period in which the performance obligation is satisfied.

Explain the revenue recognition principle and the expense recognition principle.

The revenue recognition principle dictates that companies recognize revenue when a performance obligation has been satisfied. The expense recognition principle dictates that companies recognize expenses in the period when the company makes efforts to generate those revenues.

The reason why Adjusting Entries are needed

To ensure that the Revenue Recognition and Matching Principles are followed.

The placement of Revenue Recognition and Matching Principle under

Under the Accrual Basis

Differentiate between the cash basis and the accrual basis of accounting.

Under the cash basis, companies record events only in the periods in which the company receives or pays cash. Accrual-based accounting means that companies record, in the periods in which the events occur, events that change a company's financial statements even if cash has not been exchanged.

Times when Revenue is recorded under Cash Basis Accounting

When cash is received and when expenses are recorded when cash is paid

Do Accural Basis Accounting usually requires "Adjusting Entries?"

Yes