Chapter 3 Flashcards
Time period assumption
Accountants divide the economic life of a business into artificial time periods
Year = Fiscal year
Accrual basis accounting
Companies record transactions in the period in which they occur
- Focused on when when things happen, not when cash changes hands
Cash basis accounting
Companies record transactions when they happened
- Focused on when cash change hands
Revenue recognition principle
Requires that companies recognise revenue in the accounting period in which the performance obligation is satisfied
- A company satisfies its performance obligation by performing a service or providing a good to a customer
Expense recognition principle
Requires that companies recognise expenses in the period in which they make efforts to generate revenues
“Expense follows revenues”
Paying on account
Get the service/good and pay in the future
- When you owe money - liabilities go up (you promised to pay)- credit liabilities
- When you pay on account - liabilities go down ( you are paying it off) - debit liabilities
Adjusting entries
Ensure that the revenue recognition and expense recognition principles are followed a company prepares financial statements
Deferrals or prepayment
Expenses or revenues that are recognised at a date later than the point when cash was originally exchanged → Occur when goods/services have been paid in advance
Cash happens first, recognition comes later (Delayed Dollars)
Accruals
Expenses or revenues that are recognised at an earlier date than the point when cash will be exchange in the future → occur when goods/services need to be paid in the future but the revenue is recognised first
Recognition happens first, cash comes later (Accumulated Actions)
Prepaid expenses
Deferrals
Assets that we purchase in advance, but use or consumer later to the benefit of the company
They are first recorded as assets on the balance sheet and then moved to the income statement as expenses when used or consumed
An adjusting entry for prepaid expenses results in an increase (a debit) to an expense account and a decrease (a credit) to an asset account
Unearned revenues
Deferrals
Cash that we receive in advance but earn later when we deliver the good or provide the service
They are first recorded as liabilities on the balance sheet and then moved to the income statement as revenue when the performance obligation is satisfied
The adjusting entry for unearned revenues results in a decrease (a debit) to a liability account and an increase (a credit) to a revenue account
Accrued revenues
Accruals
Revenues that we earn now as we delivered the good or provided the service. However, we will only receive the cash from the customer at a later time
They are first recorded as revenues in the income statement and are accompanied by an asset on the balance sheet to indicate that the customer still needs to pay (accounts receivables)
The adjusting entry for accrued revenues results in an increase (a debit) to an asset account and an increase (a credit) to a revenue account
Accrued expenses
Expenses that we incur now as we generate revenues but we will pay the cash later
They are first recorded as expenses in the income statement and are accompanied by a liability on the balance sheet to indicate that we will still need to pay (payable)
Depreciation
The process of allocating the cost of an asset to expense over its useful life- it is an allocation concept not a valuation concept
- It is recorded in the contra asset account
Depreciation expense formula = (Cost - Salvage Value) / Useful life
Going concern assumption
States that the business will remain in operation for the foreseeable future
