CH3 Flashcards
What is Accrual-Basis Accounting?
Under the accrual basis, companies record transactions that change a company’s financial statements in the periods in which the events occur. For example, using the accrual basis to determine net income means companies recognize revenues when they perform services (rather than when they receive cash). It also means recognizing expenses when incurred (rather than when paid).
What is Cash-Basis Accounting?
Under cash-basis accounting, companies record revenue at the time they receive cash. They record an expense at the time they pay out cash. The cash basis seems appealing due to its simplicity, but it often produces
misleading financial statements. For example, it fails to record revenue for a company that
has performed services but has not yet received payment. As a result, the cash basis may not
recognize revenue in the period that a performance obligation is satisfied.
What are the types of Adjusting Entries?
Deferrals:
Prepaid expenses: Expenses paid in cash before they are used or consumed.
Unearned revenues: Cash received before services are performed.
Accruals:
Accrued revenues: Revenues for services performed but not yet received in cash or recorded.
Accrued expenses: Expenses incurred but not yet paid in cash or recorded.
What are Prepaid Expenses?
Prepaid expenses are costs that have been fully incurred in advance, and that expire either with the passage of time (e.g., rent and insurance) or through use (e.g., supplies).
What is Depreciation?
Depreciation is the process of allocating the cost of an asset to expense over its useful life. Therefore, Depreciation is an allocation concept, not a valuation concept. That is, depreciation allocates an asset’s cost to the periods in which it is used. Depreciation does not attempt to report the actual change in the value of the asset.
What is Unearned Revenue?
When companies receive cash before services are performed, they record a liability by increasing (crediting) a liability account called unearned revenues. In other words, a company now has a performance obligation (liability) to transfer a service to one of its customers.
Unearned revenues are the opposite of prepaid expenses.
What are Accrued Revenues?
Revenues for services performed but not yet recorded at the statement date are accrued revenues.
Without the adjusting entry, assets and owner’s equity on the balance sheet and revenues and net income on the income statement are understated.
What are Accrued Expenses?
Expenses incurred but not yet paid or recorded at the statement date are called accrued
expenses. Prior to adjustment, both liabilities and expenses are understated.
What is Interest Payable?
The accrual of interest at increases a liability account, Interest Payable. It also decreases owner’s equity by increasing an expense account, Interest Expense. Interest Expense shows the interest charges for the month of October. Interest Payable shows the amount of interest the company owes at the statement date. The firm will not pay the interest until the note comes due. Companies use the Interest Payable account, instead of crediting Notes Payable, to disclose the two different types of obligations-interest and principal-in the accounts and statements. Without this adjusting entry, liabilities and interest expense are understated, and net income and owner’s equity are overstated.
What are Accrued Salaries and Wages?
This accrual increases a liability, Salaries and Wages Payable. It also decreases owner’s equity by increasing an expense account, Salaries and Wages Expense. Without the adjustment for salaries and wages, the firm’s expenses are understated, and its liabilities are understated.
What is Adjusted Trial Balance?
An Adjusted Trial Balance shows the balances of all accounts, including those adjusted, at the end of the accounting period. The purpose of an adjusted trial balance is to prove the equality of the total debit balances and the total credit balances in the ledger after all adjustments.
What are the Fundamental Qualities of Useful Information?
- Relevance
- Predictive Value
- Conformity Value
- Materiality - Faithful Representation
- Complete
- Neutral
- Free from Error
What are the Enhancing Qualities of Useful Information?
- Comparability
- Consistency
- Verifiability
- Timeliness
- Understandability
What are the Key Assumptions in Financial Reporting?
- Monetary Unit Assumption: The monetary unit assumption requires that only those things that can be expressed in money are included in the accounting records.
- Economic Entity Assumption:
The economic entity assumption states that every economic entity can be separately identified and accounted for. In order to assess a company’s performance and financial position accurately, it is important to not blur company transactions with personal transactions or transactions of other companies. - Time Period Assumption: The time period assumption (also known as the periodicity assumption) is an accounting principle that assumes a business’s financial activities can be divided into specific, standard time periods, such as months, quarters, or years. This allows businesses to prepare and report financial statements periodically rather than waiting until the company closes or completes all operations.
- Going Concern Assumption:
The going concern assumption states that the business will remain in operation for the foreseeable future. Of course, many businesses do fail, but in general it is reasonable to assume that the business will continue operating.
