Chapter 3 Notes

Created Sep 3, 2019 1054 PM

Tags

Updated Sep 5, 2019 1001 PM

Accrual Basis Accounting and Adjusting Entries

Accountants divide the economic life of a business into artificial time

periods Time Period Assumption)

Fiscal and Calendar Year

Accounting time periods are generally a month, a quarter, or a year

Monthly and quarterly are called interim periods

Fiscal Year- accounting time period that is one year in length

Usually begins the first day of the month, ends 12 months later at the
end of the month

Calendar Year- January 1 to December 31

Followed by most companies as fiscal year

Accrual versus Cash-Basis Accounting

Accrual-Basis Accounting- companies record transactions that change a

company's financial statements in the time periods in which the events
occur

Cash Basis- companies record revenue at the time they receive cash

Simple but creates misleading financial statements

Ex: If a service is performed, companies can recognize revenue when the

service is performed (accrual) or when the payment is received (cash-
basis)

Accrual-Basis is in accordance with IFRS

Recognizing Revenues and Expenses

Performance Obligation- when a company agrees to perform a service or

sell a product to a customer

Chapter 3 Notes 1
 Revenue Recognition Principle- companies should recognize revenue in the
accounting period in which the performance obligation is satisfied

Expense Recognition Principle- companies recognize expenses in the

period in which they make efforts to generate revenue

The Need for Adjusting Entries

Adjusting entries ensure that the revenue recognition and expense

recognition principles are followed

Necessary because trial balance may not contain up-to-date and complete
data

Adjusting entries are required every time a company prepares financial

statements

Every adjusting entry will include one income statement account and one
statement of financial position account

Types of Adjusting Entries

Deferrals:

Prepaid Expenses- expenses paid in cash before they are used or

consumed

Unearned Revenue- cash received before services are performed

Accruals

Accrued revenues- revenues for services performed but not yet

received in cash or recorded

Accrued expenses- expenses incurred but not yet paid in cash or

recorded

Adjusting Entries for Deferrals

Deferrals- expenses or revenues recognized at a date later than the point

when cash was originally exchanged

Prepaid Expenses

Prepaid expenses are costs that expire either with the passage of time or
through use

Not recognized daily, only when making financial statements

Chapter 3 Notes 2
 Adjusting entry for prepaid expense results in an increase to an
expense account and a decrease to an asset acount

Supplies- companies recognize supplies expense at the end of the

accounting period

Insurance- must be paid in advance, often for multiple months

Depreciation-process of allocating the cost of an asset to expense over its

useful life

Period of service of a long-term asset is the useful life of the asset

Depreciation is an allocation concept, not a valuation concept

Accumulated Depreciation- contra asset account that keeps track of

the total amount of depreciation expense taken over the life of the
asset

Discloses both the original cost of equipment and the total cost
that has been expensed to date

Book value- difference between the cost of any depreciable asset and
related accumulated depreciation

Unearned Revenues

Liability account when companies receive cash before services are

performed

Company now has a performance obligation to its customers

Opposite of Prepaid Expense

Adjusting entry for unearned revenues results in a decrease in liability

and an increase in a revenue account

Adjusting Entries for Accruals

Adjusting entry for accruals will increase both a statement of financial

position and an income statement account

Accrued Revenues

Revenues for services performed but not yet recorded at the statement
date

May accrue with the passing of time, or may result from services that have
been performed but not billed or recorded

Chapter 3 Notes 3
 Adjusting entry for accrued revenues results in an increase to an asset
account and an increase to a revenue account

Accrued Expenses

Expenses incurred but not yet paid or recorded at the statement date

Ex: Interest, taxes, salaries

Adjusting entry for accrued expenses results in an increase to an expense

account and an increase to a liability account

Accrued Interest- amount recorded is determined by face value of note,

interest rate, and length of time the note is outstanding Interest Payable
vs. Interest Expense)

Accrued Salaries and Wages

Adjusted Trial Balance and Financial Statements

Adjusted Trial Balance- trial balance prepared after journalizing and

posting all adjusting entries

Purpose is to prove the equality of total debit balances and total credit
balances after all adjustments

Primary basis for the preparation of financial statements

Companies can prepare financial statements directly from adjusted

trial balance

Chapter 3 Notes 4