Accounting Chp 3

Adjusting entries

journal entries made at the end of an accounting period to record the completed portion of partially completed transactions. Adjusting entries are necessary to apply the revenue recognition principle and matching concept and to ensure that a company's financial statements include the proper amount for revenues, expenses, assets, liabilities, and shareholders' equity.

Step to preparing a financial statement

1. The income statement is prepared from the revenue and expense accounts. 2. Net income is used to prepare the statement of retained earnings. 3. The statement of financial position is prepared using the ending balance of retained earnings from the statement of retained earnings.

five conditions that must all be met in order to recognize revenue.

1. The significant risks and rewards of ownership of the goods must have been transferred to the purchaser by the seller. The transfer of legal title, the delivery of goods to a customer, or the performance of services for a customer usually meets this requirement. 2. The amount of revenue must be reliably measurable. The amount to be collected by the seller must not be uncertain. 3. Continuing managerial involvement to the degree usually associated with ownership should not be retained by the seller, nor should the seller maintain effective control over the goods sold. 4. It must be probable that the economic benefits (usually payment) associated with the transaction will flow to the seller. If the customer is creditworthy, this condition would normally be satisfied. 5. Costs incurred or to be incurred with respect to the transaction must be reliably measurable. If costs cannot be reliably measured, revenue cannot be recognized.

Prepaid expenses:

Assets arising from the payment of cash that have not been used or consumed by the end of the period

Unearned revenues:

Liabilities arising from the receipt of cash for which revenue has not yet been earned

Accrued expenses:

Previously unrecorded expenses that have been incurred but not yet paid in cash

Accrued revenues:

Previously unrecorded revenues that have been earned but for which no cash has yet been received

REVENUE RECOGNITION

Revenue is recognized when the service has been rendered, goods have been delivered, or work has been completed. Payments received in advance are deferred until services are rendered or products are delivered.

Process to closing accounts

Step 1: Close revenues to income summary. Step 2: Close expenses to income summary. At this point, the balance in the income summary account should be equal to net income (or net loss). Step 3: Close income summary to retained earnings. Step 4: Close dividends declared to retained earnings.

process of adjusting journal entries.

Step 1: Identify the income statement and statement of financial position accounts that require adjustment. Step 2: Calculate the amount of the required adjustment based on the amount of revenue that was earned or the amount of expense that was incurred during the accounting period. Step 3: Record the adjusting journal entry. Step 4: Prepare the adjusted trial balance to ensure that the trial balance remains in balance after the adjusting entries have been posted.

temporary accounts

These accounts are used to collect the activities of only one period

cash-basis accounting

Under cash-basis accounting, revenue is recorded when cash is received, regardless of when it is actually earned. Similarly, an expense is recorded when cash is paid, regardless of when it is actually incurred. Therefore, cash-basis accounting does not link recognition of revenues and expenses to the actual business activity but rather to the exchange of cash

permanent accounts

accounts in that their balances are carried forward from the current accounting period to future accounting periods.

Contra accounts

accounts that have a balance that is opposite of the balance in a related account. In this case, Accumulated Depreciation—Building is a contra account to the building asset account.

Accrual-basis accounting

an alternative to cash-basis accounting and is required by IFRS and ASPE. Under accrual accounting, transactions are recorded when they occur. Accrual accounting is superior to cash-basis accounting because it links income measurement to the earnings activity of the company.