Chapter 3 Notes
Created Sep 3, 2019 1054 PM
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Updated Sep 5, 2019 1001 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