The accrual basis of accounting and the reasons for adjusting entries

TIME-PERIOD ASSUMPTION
-The time period (or periodicity) assumption assumes that the economic life of a
business can be divided into artificial time periods.
-Accounting time periods are generally a month, a quarter, or a year.
-The accounting time period of one year in length is referred to as a fiscal year.
THE MATCHING PRINCIPLE
-The practice of expense recognition is referred to as the matching principle.
-The matching principle dictates that efforts (expenses) be matched with
accomplishments (revenues).
ACCRUAL BASIS OF ACCOUNTING (應計制原則)
-Under accrual basis accounting, transactions that change a company's financial
statements are recorded in the periods in which the events occur.
-The revenue recognition and matching principles are used under the accrual basis.
-Under cash basis accounting, revenue is recorded when cash is received, and
expenses are recorded when cash is paid.
-Generally accepted accounting principles require accrual basis accounting.
CASH BASIS ACCOUNTING (現金收付會計)
-Revenue is recognized when cash is received.
-Expenses are recognized only when cash is paid.
ACCRUAL VERSUS CASH ACCOUNTING
ADJUSTING ENTRIES
-Adjusting entries are needed to ensure that the revenue recognition and matching
principles are followed.
-Accrual basis accounting usually requires "adjusting entries."
-Adjusting entries are entries for which there may or may not be "source
documents" such as invoices or sales receipts.
-Adjusting entries are required each time financial statements are prepared.
-Adjusting entries can be classified as
Deferrals (prepaid expenses or unearned revenues)
Accruals (accrued revenues or accrued expenses)

PREPAID EXPENSES
-Prepaid expenses are 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.
-An asset-expense account relationship exists with prepaid expenses.
-Prior to adjustment, assets are overstated and expenses are understated.
-The adjusting entry results in a debit to an expense account and a credit to an asset
account.
-Examples of prepaid expenses include supplies, insurance, and depreciation.
ADJUSTING ENTRIES FOR DEFERRALS: SUPPLIES

ADJUSTING ENTRIES FOR DEFERRALS: INSURANCE

DEPRECIATIONI (折舊)
-Depreciation is the allocation of the cost of an asset to expense over its useful life
in a rational and systematic manner.
-The purchase of equipment or a building is viewed as a long-term prepayment of
services and, therefore, is allocated in the same manner as other prepaid expenses.
-Depreciation is an estimate rather than a factual measurement of the cost that has
expired.
-In recording depreciation, Depreciation Expense is debited and a contra asset
account, Accumulated Depreciation, is credited.
Depreciation Expense
XXX

Accumulated Depreciation
XXX
-In the balance sheet, Accumulated Depreciation is offset against the asset account.
-The difference between the cost of any depreciable asset and its related
accumulated depreciation is referred to as the book value of the asset.
Office Equipment
Oct. 1 5,000

Accumulated Depreciation — Office Equipment

Oct. 31 Adj 40

Depreciation Expense

Oct. 31 Adj 40
UNEARNED REVENUES
-Unearned revenues are revenues received and recorded as liabilities before they
are earned.
-Unearned revenues are subsequently earned by rendering a service to a customer.
-A liability-revenue account relationship exists with unearned revenues.
-Prior to adjustment, liabilities are overstated and revenues are understated.
-The adjusting entry results in a debit to a liability account and a credit to a revenue
account.
-Examples of unearned revenues include rent, magazine subscriptions, and
customer deposits for future services.
TYPES OF ADJUSTING ENTRIES
Accruals
Accrued Revenues ( 應計收入)
Revenues earned but not yet received in cash or recorded.
Accumulate with the passing of time or through services performed but not billed
or collected.
An asset-revenue account relationship exists with accrued revenues.
Prior to adjustment, assets and revenues are understated.
The adjusting entry requires a debit to an asset account and a credit to a revenue
account.

Accrued Expenses (應計費用)

Expenses incurred but not yet paid in cash or recorded.
Accrued expenses are expenses incurred but not paid yet.
A liability-expense account relationship exists.
Prior to adjustment, liabilities and expenses are understated.
The adjusting entry results in a debit to an expense account and a credit to a
liability account.
PREPARATION OF FINANCIAL STATEMENTS
-The income statement is prepared from the revenue and expense accounts.
-The retained earnings statement is derived from the retained earnings account,
dividends account, and net income.
-The balance sheet is prepared from the asset, liability, and equity accounts.
Retained earnings balance comes from retained earnings statement.
-Financial statements are prepared from the adjusted trial balance.

Step:
1 prepare a trial balance
2 make adjusting entries
3 prepare an adjusted trial balance
4 prepare the income statement
4 prepare the retained earnings statement
6 prepare the balance sheet
DIFFERENCES BETWEEN NET INCOME AND CASH PROVIDED BY
OPERATING ACTIVITIES
QUALITY OF EARNINGS
-Earnings management is the planned timing of revenues, expenses, gains, and
losses to smooth out bumps in income.
-Quality of earnings is greatly affected when a company manages earnings to meet
targeted earnings.
-A company with a high quality of earnings provides full and transparent
information that will not confuse or mislead users of the financial statements.
CLOSING ENTRIES
-Closing entries transfer the temporary or nominal account balances to the
permanent stockholders’ equity account – retained earnings.
-Revenue accounts, expense accounts, and dividends are all temporary account

THE ACCOUNTING CYCLE