Chapter 3: Adjusting The Accounts Flashcards
Qualities of Useful Financial information
- Comparable
- Verifiable
- Understandable
- Consistent
- Timely
Relevance (for Financial information)
Financial Information must:
- Make a difference in a business decision
- Have predictive and/or confirmatory value
- Be material to the business (of a size that it is likely to matter to an investor or creditor)
Cost Constraint
When determining accounting standards those setting standards weigh the cost companies will incur to provide the information against the benefit of the information to financial statement users
Full Disclosure Principle
Requires that companies disclose all circumstances and events that would make a difference to financial statement users
Residual Value
Expected value of a depreciable asset at the end of its natural life
Adjusting Entries
- Ensure that the revenue recognition and matching principles are followed (expense recognition)
- Required every time financial statements are prepared
- Will always include one income statement and one balance sheet account
Contra Account
Account paired with a listed immediately after it’s related account in the chart of accounts and on the financial statements
normal balance is opposite of the normal balance of its related account
Worksheet
An internal document that helps summarize data for the preparation of financial statements.
Generally in excel
Sections:
1) Account Names
2) Unadjusted Trial Balance
3) Adjustments
4) Adjusted Trial Balance
5) Income Statement
6) Balance Sheet
7) Net Income or Loss
Depreciation
The process of allocating the cost of an asset to expense over its useful life
Accumulated depreciation is a contra-asset account
NOT an attempt to report the accurate change in (fair market) value. Allocation, not valuation
Book Value
The difference between the cost of an asset and its accumulated depreciation (remaining value)
Accrual Accounting
As opposed to cash-basis accounting
- Revenue increased when company performs work, not when it receives payment
- Expenses increase when company INCURS expenses, not when expenses are paid
Transaction recorded when events occur - not when they are paid for
Required per GAAP and IFRS
Cash-Basis Accounting
As opposed to Accrual Accounting
- Revenue increases when cash is received / Expenses increase when cash is paid out
NOT in accordance with GAAP
Revenue Recognition Principle
Emphasizes when obligations are satisfied
Companies recognize revenue in the accounting period in which it is earned
5 steps:
1) identify the contract
2) identify the performance obligations
3) determine the transaction price
4) allocate the transaction price to the obligations
5) recognize revenue when obligations are satisfied
Matching Principle
Also: Expense Recognition Principle
Per GAAP must match expenses with revenues in the period where the company makes the effort to generate those revenues (recorded when incurred)
Temporal Distortion:
If expense period is shorter than revenue period: earnings understated in early years, overstated later
if expense period is longer than revenue period:
earnings overstated in early years, understated later
Adjusting Entry for Accrued Expenses
Debit Expense account (increase)
Credit Liability Account (increase)
If not adjusted expenses are understated, liabilities understated
shows expenses incurred but not yet paid for
