Chapter 3 Adjusting the Accounts I timing Issues time periods A Time Period Assumptions divide the economic life of a business into artificial 1 2 Fiscal Year B Accrual Based Accounting Interim Periods monthly and quarterly time periods accounting time period that is one year in length companies record transactions that change a company s financial statement in the periods in which the event occurs 1 companies recognize income when they perform the service rather than when they receive the cash 2 Companies recognize expenses when incurred rather than when paid companies record revenue when they receive cash and C Cash Bais Accounting record expense when they pay out cash 1 NOT GAAP APPROVED D Recognizing Revenue and Expenses 1 Revenue Recognition Principal revenue in the accounting period in which it is earned dictates that companies reorganize a Customer requests service Service Performed received b Revenue should be recognized when the service is performed 2 Expense Recognition Principal Matching Principal with revenue in the period when the company makes efforts to generate those revenue match expenses II Adjusting Entries revenue recognition and expenses recognition are followed A Why trial balance may not be accurate 1 some events are not recoreded daily because it is to inefficient to do so small sales salaries interest supplies 2 some not recorded because they expire with the passage of time versus from use in transactions rent insurance 3 some items unrecorded utility bill that will come due next period B Types of Adjusting Entries 1 Deferrals prepaid expenses or unearned revenue a Prepaid expenses ASSET i when expense is prepaid and asset account is increased debited to show wervice to the company will receive in the future ii Costs that expire with the passage of time rent insurance or through use supplies iii Credit asset account and debit expense account for what was used iv deprecation of long term assets Accounting for Prepaid Expenses Reasons for Adjustment Account Before Adjustment Adjusting Entry Examples Insurance Supplies Rent depreciation Prepaid expenses recorded in asset account have been used Examples Rent subscriptoins customer deposits for future service Assets Overstated Expenses Understated Debit Expenses Credit Assets companies record cash received before b Unearned Revenue revenue is earned by increasing a liability account called unearned revenue Accounting for Unearned Revenue Reasons for Adjustment Account Before Adjustmetn Adjusting Entry Liabilities Overstated Revenue Understated Unearned Revenues recorded as liability accounts have been earned make adjusting entries to record revenue earned and 2 Accruals expenses incurred in the current accounting period that have not been recognized through daily entries a Accrued Revenue statement date revenue earned but not yet recorded at Debit Liabilities Credit Revenue shows the receivable that exist at the balance sheet date i ii it records the revenues earned during the period Accounting for Accrued Revenue Reasons for Adjustment Account Before Adjustmetn Adjusting Entry Examples Interest Rent services performed but not collected Revenues have been earned but not yet received in cash or recorded Revenues Understated Assets Understated Debit Assets Credit Revenue b Accrued Expenses recorded at the statement date expenses incurred but not yet paid or i accrued expense for one company is accrued revenue for another ii It records the obligation that exists iii recognizes the expense on the current period Accounting for Accrued Expense Account Before Adjustmetn Adjusting Entry Examples Interest Rent Salaries Reasons for Adjustment Expenses have been incurred but not yet paid in cash or recorded Expenses Understated Liabilities Understated Debit Expenses Credit Liabilities
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