Accounting Chap 5 Flashcards
PREPARE END-OF-PERIOD ADJUSTMENTS
Changes occur that affect the business’s financial condition:
Equipment wearing out
Prepaid insurance and supplies being
used up
Employees earning wages that have not yet been paid
Since these events have not been entered into the accounting system, ADJUSTING ENTRIES must be made
reflect changes in account balances not involving an exchange with an outside party.
Adjusting entries:
the matching of a specific period’s revenues and expenses, requires accounts to be brought up to date before financial statements are prepared.
MATCHING PRINCIPLE:
MATCHING PRINCIPLE:
Requires the matching of REVENUES EARNED during an accounting period with the EXPENSES INCURRED
Provides the best measure of net income
Necessitates accounts be brought up to date before financial statements are prepared
- Reasons to Adjust the Trial Balance
a) Report all revenue earned.
b) Report all expenses incurred.
c) Accurately report the assets that have been used up.
d) Accurately report the liabilities that have been incurred but not yet paid.
A 12-month period of time used as an accounting period
FISCAL YEAR:
FISCAL YEAR:
Adjustments are made and financial statements are prepared at the end of a 12-month period.
Does not need to be the same as a calendar year
Many businesses schedule their fiscal year to end when business is slow
Uses of supplies Examples: Office supplies Beginning inventory $100 Ending inventory $20 $100 - $20 = $80
Debit office supplies expense $80.00.
Credit office supplies $80.00.
Loss in value of a fixed asset due to wear and tear and passage of time. Method of matching cost of a fixed asset against revenue that the fixed asset will help produce during the useful life.
Depreciation
HISTORICAL COST PRINCIPLE
Assets are recorded at their actual cost
The cost remains on the books as long as the business owns the asset
No adjustments are made for changes in the market value of the asset
The period of time that an asset is expected to help produce revenues
Useful life
Useful life
Useful life expires as a result of wear and tear or because it no longer satisfies the needs of the business
As this happens, depreciation expense should be recognized and the value of the asset should be reduced
Amount originally paid for a depreciable asset.
Original cost basis
The expected market value or selling price of an asset at the end of its useful life
Also called:
Scrap value, or
Residual value
Salvage value
Depreciation is a method of matching an asset’s original cost against the revenue produced over the useful life
Depreciation expense
Depreciable cost = Cost – Salvage Value
Book Value = Cost – Accumulated Depreciation
is the difference between cost and accumulated depreciation. It is not the same as market value and not intended to represent the selling price of the asset.
Book value, or undepreciated cost,
means against or opposite
“Contra”
“Contra”
Has a credit balance (the opposite of an asset)
Is deducted from the related asset account on the balance sheet
THE WORK SHEET
Pulls together all of the information needed to:
Enter adjusting entries
Prepare financial statements
Is not a financial statement
Is not a formal part of the accounting system
Ordinarily, only the accountant uses a work sheet
Commonly in a 10-column format
PREPARING THE WORK SHEET
5 STEPS
- Prepare the Trial Balance.
- Prepare the Adjustments.
- Prepare the Adjusted Trial Balance.
- Extend Adjusted Balances to the Income Statement and Balance Sheet columns.
- Complete the Work Sheet.
JOURNALIZING ADJUSTING ENTRIES
A. Post to the general ledger in the same manner as all other journal entries.
B. Write “Adjusting” in the Item column of the general ledger.
- Revenues are recorded when earned.
- Expenses are recorded when incurred.
- Measures income best for most businesses.
Accrual basis of accounting
Accrual basis of accounting
Revenues are recorded when EARNED
Expenses are recorded when INCURRED
Recognizes receivables and payables
Offers the best matching of revenues and expenses
The best method of measuring income for most businesses
Smaller service organizations often use the cash or modified cash basis
- Revenues are recorded when cash is received.
- Expenses are recorded when cash is paid.
- Does not recognize prepaid assets or long-term assets.
Cash basis of accounting
Cash basis of accounting
Revenues are recorded when cash is RECEIVED
Expenses are recorded when cash is PAID
Similar to the accrual basis if:
There are few receivables, payables, and assets
Can vary significantly if:
A business has many receivables, payables, and assets
- Uses the cash basis for recording revenue and expenses.
- Assets acquired other than cash are recorded as assets instead of being recorded as expenses.
- Does not account for receivables or for payables for services rendered.
Modified cash basis of accounting
Modified cash basis of accounting
Combines aspects of the cash and accrual methods
A business uses the cash basis for recording revenues and most expenses
Exceptions are made when cash is paid for assets with useful lives greater than one accounting period
If cash is paid for equipment, buildings, supplies, or insurance, these are recorded as assets, and adjustments are made each period as under the accrual basis
Depreciation of an asset is apportioned equally over its estimated useful life.
Expressed in terms of months or years.
Straight line method
Most common Methods for calculating depreciation
Straight line method
Straight-Line Method
A. An equal amount of depreciation will be taken each period.
B. Depreciation Expense per Year = (Cost – Salvage Value) /Years of Life
C. Rate of depreciation = 100% /Years of Life
D. A depreciation schedule is prepared showing the depreciation expense, accumulated depreciation, and book value for each year.
