CH.3 Adjusting The Accounts Flashcards
In Chapter 2 we examined the recording process through the preparation of the trial balance. Before we will be ready to prepare financial statements from the trial balance, additional steps need to be taken. Before financial statements can be prepared, questions relating to the recognition of revenues and expenses must be answered. With the answers in hand, the relevant account balances can then be adjusted.
Explain the time period assumption
The time period (or periodicity) assumption assumes that the economic life of a business can be divided into artificial time periods.
Accounting time periods are generally a month, a quarter, or a year. The accounting time period of one year in length is usually known as a fiscal year.
Explain the accrual basis of accounting
The revenue recognition and matching principles are used under the accrual basis of accounting. Under cash basis accounting, revenue is recorded only when cash is received and expenses are recorded only when paid.
GAAP require accrual basis accounting rather than cash basis accounting because the cash basis of accounting often leads to misleading financial statements.
Explain the meaning of revenue recognition principle
The revenue recognition principle states that revenue should be recognized in the accounting period in which it is earned.
Explain the meaning of the matching principle
The matching principle dictates that efforts (expenses) be matched with accomplishments (revenues).
Explain the reasons for adjusting entries
Adjusting entries are made in order for:
a. Revenues to be recorder in the period in which they are earned, and for expenses to be recognized in the period in which they are incurred.
b. The revenue recognition and matching principles to be followed.
Adjusting entries are required every time financial statements are prepared. Adjusting entries can be classified as (a) deferrals (prepaid expenses or unearned revenue) or (b) accruals (accrued revenues or accrued expenses).
Explain deferrals
Prepaid expenses are expenses paid in cash and recorded as assets before they are used or consumed. Examples of prepaid expenses include supplies, insurance, and depreciation.
Unearned revenues are revenues received and recorded as liabilities before they are earned. Examples of unearned revenues include rent, magazine subscriptions, and customer deposits for future service.
Explain depreciation
Depreciation is the process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner.
Explain accruals
Accrued revenues are revenues earned but not yet recorded at the statement date. Accrued revenues may accumulate with the passing of time as in the case of interest and rent, or through services performed but for which payment has not been collected.
Accrued expenses are expenses incurred but not yet paid or recorded at the statement date. Accrued expenses result from the same causes as accrued revenues and include interest, rent, taxes, and salaries.
