Chapter 3: Adjusting the Accounts Flashcards
What is the accrual basis of accounting?
The accrual basis involves adjusting the accounts to reflect the impact of all transactions related to a given period, whether the transaction actually occurred in that period. This ensures that revenues and expenses are stated accurately for each period. Accrual accounting records revenues when they are earned and expenses when they are incurred.
Why do we prepare adjusting entries?
To ensure that the general ledge accounts reflect the financial impact of all transactions within that particular period, even though the evidence of some transactions has not been prepared or received yet. This is done every time a company prepares financial statements.
Explain the adjusting entry for prepayments - prepaid expenses.
We use an adjusting entry to record the amount of the prepaid expense that has been used up in the current accounting period to reduce the asset account where the prepaid expenses was originally recorded. As the prepayment has been used up, it is no longer an asset. Prepaid expenses are assets that expire with the passage of time or through use.
Example: Credit Supplies, Debit Supplies Expense.
Explain the adjusting entry for prepayments - depreciation expenses.
Assets that have long lives (land, buildings, and equipment) provide service for a number of years. The length of service is called the useful life. Companies record these assets at cost. The adjusting entry is used to recognize a portion of the cost of the long lived asset, called depreciation. The difference between the cost and the accumulated deprecation is called the carrying amount of that asset.
Cost / Useful Life in Years = Annual Depreciation Expense.
Example: Debit Depreciation Expense, Credit Accumulated Depreciation - Land
Explain the adjusting entry for Prepayments - Unearned Revenues.
The adjusting entry records the revenue to be recognized in the current period and reduces the liability account where the unearned revenue was originally recorded. This is necessary because the unearned revenue is no longer owed so we have to recognize the revenue.
Example: Debit Unearned Revenues, Credit Revenue
Explain the adjusting entry for Accruals.
We use adjusting entries to record transactions that have taken place, but no cash has been transfered (ex. Recognizing revenue without receiving payment, or recognizing an expense for the period for which it applies, without receiving the bill)
Example: Debit interest expense, Credit Interest Payable
Example: Debit accounts receivable, Credit Revenue
