Chapter 3 Notes
Chapter 3 Notes BA 210
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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