Rachel Coe Financial Accounting 2021 Chapter 4 Accrual Accounting Concepts Timing Issues accountants divide the economic life of a business into artificial time periods Periodicity Assumption generally a month quarter or year Fiscal year accounting time period that is one year vs calendar year o Fiscal year MUST end at the end of a month The Revenue Recognition Principle Companies recognize revenue in the accounting period in which the performance obligation is satisfied Customer requests a service service is performed cash is recived This process might not all occur in the same year but revenue should only be recorded when the service is performed not just when cash is received Expense Recognition Principle Very similar to revenue except negative Match expenses with revenues in the period when the company makes efforts to generate those revenues Let the expenses follow the revenues Cash is unrelated to these concepts o Accrual versus Cash Basis of Accounting Cash Basis Accounting Revenues are recognized only when cash is received Expenses are recognized only when cash is paid Prohibited under generally accepted accounting principles Hardly ever used by businesses Accrual Basis Accounting Transactions recorded in the periods in which the events occur Revenues are recognized when services are performed even if cash was not received Expenses are recognized when incurred even if the cash was not paid The Basics of Adjusting Entries Ensure that the revenue recognition and expenses recognition principles are followed Included one income statement account and one balance sheet account Are required every time a company prepares financial statements NEVER include cash Types of Adjusting Entries o Deferrals 1 Prepaid expenses Expenses paid in cash and recorded as assets before they are used or consumed Insurance Asset Accounts that tend to expire with a passage of time 2 Unearned revenues Cash received before service are performed Liabilities o Accruals 1 Accrued revenues Revenues for services performed but not yet received in cash or recorded 2 Accrued expenses Expenses incurred but not yet paid in cash or recorded Trial Balance each account is analyzed to determine whether it is complete an up to date Adjusting Entries for Prepaid Expenses o Payment of cash that is recorded as an asset because service or benefit will be received in the future o Cash payment BEFORE Expense recorded o Prepayments often occur in regard to Insurance Supplies Advertising Rent Equipment Buildings o Prepaid Expenses use o Depreciation Costs that expire either with the passage of time or through Adjusting entry results in an increase a debit to an expense account and a decrease a credit to an asset account Debits Credits When a supplies cost goes to debit eventually some supplies will get used up and there may be leftovers Once the portion of supplies are used up the cost changes from a debit to an expense under credit Buildings equipment and motor vehicles long lived assets are recorded as assets rather than an expense in the year acquired Companies report a portion of the cost of a long lived asset as an expense depreciation during each period of the asset s useful life Depreciation does not attempt to report the actual change in the value of the asset Crediting an asset DECREASES it We CREDIT accumulated depreciation and balance the Debiting an expense INCREASES it o Statement Presentation Accumulated Depreciation Equipment is a contra asset debit account It appears just after the account it offsets Equipment on the balance sheet Unearned Revenues receipt of cash recorded as a liability before services are performed Cash receipt BEFORE revenue recorded Unearned revenues often occur in regard to o Rent o Airline tickets o Magazine subscriptions o Customer deposits Adjusting entry to record the revenue that has been earned and to show the correct amount of liability that remains Adjusting entry results in a decrease DEBIT to a liability account and an increase CREDIT to a revenue account Adjusting Entries for Accruals Made to record Revenues earned OR expenses incurred in the current accounting period that have not been recognized through daily entries BEFORE cash changes hands Accrued revenues often occur o Rent o Interest o Services performed An adjusting entry serves two purposes o Shows the receivable that exists o Records the revenues for services performed Accrued revenues increases an asset account DEBITS and increases CREDIT a revenue account Accrued Expenses often occur o Rent o Interest o Taxes o salaries An adjusting entry serves two purposes o Records the obligations o Recognizes the expenses CREDITS a liability account Calculating Interest Accrued expenses increases DEBITS an expense account and increases FACE VALUE OF NOTE ONE YEAR The Adjusted Trial Balance X ANNUAL INTEREST RATE X TIME IN TERMS OF After all entries are journalized and posted the company prepares another trial balance from the ledger accounts adjusted trial balance The adjusted trial balance s purpose is to prove the equality of debit balances and credit balances in the ledger The adjusted trial balance is the primary basis for the preparation of the financial statements Closing the Books accounts Temporary all revenue accounts all expense accounts dividends Permanent all asset accounts all liability accounts stockholder s equity At the end of the accounting period companies transfer the temporary account balance to the permanent stockholder s equity account retained earnings Income summary revenue accounts and expense accounts Income summaries dividends retained earnings
View Full Document
Unlocking...