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Chapter 3 Notes

by: Amelia Cassidy

Chapter 3 Notes BA 210

Amelia Cassidy

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About this Document

These notes cover chapter 3, as covered in the class lecture and textbook
Financial Accounting
Dr. Greenman
Class Notes
business, Accounting, financial accounting
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This 12 page Class Notes was uploaded by Amelia Cassidy on Tuesday March 1, 2016. The Class Notes belongs to BA 210 at Embry-Riddle Aeronautical University - Daytona Beach taught by Dr. Greenman in Spring 2016. Since its upload, it has received 34 views. For similar materials see Financial Accounting in Business at Embry-Riddle Aeronautical University - Daytona Beach.


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Date Created: 03/01/16
Chapter 3 ­ Adjusting the Accounts        ● Timing Issues  ○ Time Period Assumption Definition  ■ Also called ​ Periodicity Assumption  ■ Accountants divide economic life of business into artificial time  periods  ○ Transactions can affect more than one time period  ■ Determine relevance of transaction to specific accounting periods  ○ Public companies prepare quarterly/annual financial statements  ■ Only one has to be audited  ○ Fiscal and Calendar Years  ■ Accounting time periods are generally monthly, quarterly, yearly  ■ Interim Periods Definition  ● Monthly/Quarterly accounting time periods  ■ Fiscal Year Definition  ● An accounting period that is one year in length  ● Begins w/first day of month, ends 12 months later on last  day of month  ■ Calendar Year Definition  ● Accounting period extending from January 1 ­ December 31  ○ Accrual­ Versus Cash­Basis Accounting  ■ Accrual­Basis Accounting Definition  ● Accounting basis in which companies record transactions  that change company’s financial statements in periods in  which events occur  ■ Cash­Basis Accounting Definition  ● Companies record revenue when they receive cash and an  expense when they pay cash  ● Fails to record revenue for company that provides services  but does not receive cash  ● Does not match expenses w/earned revenue  ● Not in accordance with GAAP  ○ Recognizing Revenues and Expenses  ■ Revenue Recognition Principle  ● Revenue Recognition Principle Definition  ○ Principle that companies recognize revenue in  accounting period in which performance obligation is  satisfied    ■ Expense Recognition Principle  ● “Let expenses follow revenues”  ● Expense Recognition Principle Definition  ○ Known as ​ Matching Principle  ○ Principle that companies match efforts (expenses)  w/accomplishments (revenues)      ● The Basics of Adjusting Entries  ○ Adjusting Entries Definition  ■ Entries made @ end of accounting period to ensure that companies  follow revenue/expense recognition principles  ○ Necessary b/c trial balance may not contain up­to­date/complete data  ○ Required every time company prepares financial statements   ■ Include 1 income statement account, 1 balance sheet account  ○ Types of Adjusting Entries  ■ Deferrals Definition  ● Adjusting entries for prepaid expenses/unearned revenues  ● Costs/Revenues recognized @ later date than point when  cash was originally exchanged  ■ Accruals Definition  ● Adjusting entries for accrued revenues/accrued expenses    ○ Adjusting Entries for Deferrals  ■ Prepaid Expenses  ● Prepaid Expenses/Prepayments Definition  ○ Expenses paid in cash before they are used or  consumed  ○ Costs that expire w/passage of time or through use  ● Prepaid = increase in assets  ● Adjusting Entry for prepaid expense results in increase  (debit) to expense account and decrease (credit) to asset  account    ● Supplies  ○ Increase/Debit to assets  ○ Company recognize supply expense @ end of  account period            ● Insurance  ○ Protect themselves from losses due to  fire/theft/unforseen events  ○ Paid in advance, for more than 1 year  ○ Cost of insurance (premiums)       ● Depreciation  ○ Useful Life Definition  ■ Length of service of long­lived asset  ○ Depreciation Definition  ■ Allocation of cost of an asset to expense of  useful life in rational/systematic manner  ■ Does not report actual change in value of asset    ● Need for Adjustment  ○ Contra Asset Account Definition  ■ Account offset against an asset account on  balance sheet  ■ All have increases, decreases, normal  balances opposite to account to which they  relate    ● Statement Presentation    ○ Book Value Definition  ■ Difference between cost of depreciable asset &  related accumulated depreciation  ■ Carrying value  ○ Purpose of depreciation is not valuation but means of  cost allocation         ■ Unearned Revenues    ● Unearned Revenues Definition  ○ Cash received before services are performed  ○ Has performance obligation (liability)  ○ Also called deferred revenue  ● Opposite of prepaid expenses  ● Adjusting entry for unearned revenues results in  decrease/debit to liability account & increase/credit to  revenue account    ○ Adjusting Entries for Accruals  ■ Adjusting entry for accruals increase both balance sheet/income  statement account  ■ Accrued Revenues    ● Accrued Revenues Definition  ○ Revenues for services performed but not yet received  in cash/recorded  ● Adjusting entry for accrued revenues results in  increase/debit to asset account & increase/credit to revenue  account             ● W/o adjusting entry, assets/stockholders’ equity on balance  sheet/revenues/net income on income statement are  understated  ● Equation Analysis   ○ Summarize effects of transactions on three elements  of accounting equation, as well as cash flows         ■ Accrued Expenses  ● Accrued Expenses Definition  ○ Expenses incurred but not yet paid in cash/recorded  ● Adjusting entry for accrued expenses results in  increase/debit to expense account & increase/credit to  liability account    ● Accrued Interest          ○ When computing interest, time period is expressed as  fraction of a year  ○ W/O adjusting entry, liabilities & interest expenses are  understated, net income/stockholders’ equity are  overstated        ● Accrued Salaries and Wages    ○ W/O adjustment for salaries/wages, expenses &  liabilities = understated,   ○ Entry eliminates liability for salaries/wages payable    ○ Summary of Basic Relationships  ■ Each adjusting entry affects one balance sheet account & one  income statement account  ■ Should not involve debit/credit to cash                                  ● The Adjusted Trial Balance & Financial Statements  ○ Adjusted Trial Balance Definition  ■ List of accounts & balances after company has made all  adjustments  ■ Prove equality of total debit/credit balances  ■ Primary basis for preparation of financial statements  ○ Preparing the Adjusted Trial Balance         ○ Preparing Financial Statements  ■ Companies can prepare financial statements directly from adjusted  trial balance           


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