Chapter 4 Flashcards
Accrual-Basis accounting definition
Accounting basis in which companies record, in the periods in which the events occur, transactions that change the companies’ financial statements, even if cash was not exchanged
Accrued expenses definition
Expenses incurred but not yet paid in cash or recorded
Accrued revenues definition
Revenues for services performed but not yet received in cash or recorded
Adjustments definition
Changes made to accounts at the end of an accounting period to ensure that the revenue recognition and expense recognition principles are followed
Book value definition
The difference between the cost of a depreciable asset and its related accumulated depreciation
Cash-basis accounting definition
Accounting basis in which a company records revenue only when it receives cash and an expense only when it pays cash
Contra asset account definition
An account that is offset against an asset account on the balance sheet
Depreciation definition
The process of allocating the cost of an asset to expense over its useful life
Expense recognition principle definition
The principle that companies recognize expenses in the period in which they make efforts (consume assets or incur liabilities) to generate revenues
Fiscal year definition
An accounting period that is one-year long
Periodicity assumption definition
As assumption that the economic life of a business can be divided into artificial time periods
Prepaid expenses (prepayments) definition
Expenses paid in cash before they are used or consumed
Revenue recognition principle definition
The principle that companies recognize revenue in the accounting period in which the performance obligation is satisfied
Unearned revenue definition
Cash received and a liability recorded before services are performed
Useful life definition
The length of a service of a productive asset
What are the 5 steps of the revenue recognition principle?
- Identify the contract with customers
- Identify the separate performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the separate performance obligation
- Recognize revenue when each performance obligation is satisfied
What is the critical issue in expense recognition?
Determining when the expense makes it contribution to revenue.
*This may or may not be in the same period in which the expense is paid.
Name one Pro and 2 Cons of cash-basis accounting
Pro- Simplicity
Con- Produces misleading financial statements
Con- Not in accordance with GAAP
Why are adjustments necessary?
The first pulling of transaction data may not contain up to date/ complete data
- Some events are not recorded daily because it is inefficient
- Use of supplies, employee wages
- Some costs are not recorded during the accounting period because these costs expire with the passage of time rather than as a result of recurring daily transactions
- Rent, use of insurance
- Some items may not have been invoiced and are unrecorded
- Utility bill
When are adjustments required?
Every time a company prepares financial statements
What are the two things every adjustment will include?
- One income statement account
2. One balance sheet account
Name the two types of adjustments
- Accruals
2. Deferrals
What are the 2 types of deferrals?
- Unearned revenue
2. Prepaid expenses
What are the 2 types of accruals?
- Accrued revenues
2. Accrued expenses
What does defer mean?
To postpone or delay
Deferrals definition
Costs or revenues that are recognized at a date later than the point when cash was originally exchanged
Examples of prepaid expenses
- Insurance
- Supplies
- Rent
- Advertising
- Purchase buildings and equipment
Prepaid expenses before adjustments show:
After adjustments:
Assets overstated
Expenses understated
Increase to expenses
Decrease to assets (or increase contra-assets)
Do adjustments have any effect on cash flow?
No
Why does depreciation need to be adjusted?
The acquisition of a long-lived asset is essentially a long-term prepayment for the use of an asset
Is depreciation an allocation or valuation concept?
Allocation
Does depreciation record the actual change in value of the asset?
No
What is accumulated depreciation considered?
Contra asset account
What does accumulated depreciation track?
The total amount of depreciation expense taken over the life of the asset
What is the opposite of a prepaid expense?
Unearned revenue
Unearned revenue is listed on the balance sheet as a ______
Liability
Unearned revenues before adjustments show:
After adjustments:
Liabilities overstated
Revenues understated
Increased revenues
Decreased liabilities
Examples of unearned revenues
- Rent
- Magazine subscriptions
- Customer deposits for future services
Adjustments to accruals will have what effect on the balance sheet and income statement?
Increase balance sheet account
Increase income statement account
Examples of accrued revenues
- Commissions
- Fees
- Service revenues
Accrued revenues before adjustments show:
After adjustments:
Assets understated
Revenues understated
Increased revenues
Increased assets
Examples of accrued expenses
- Interest
- Taxes
- Utilities
- Salaries
Accrued Interest is affected by which 3 factors?
- The face value of the note
- The interest rate
- The length of time the note is outstandinf
How is the interest rate always expressed?
As an annual rate
Accrued expenses before adjustments show:
After adjustments:
Expenses understated
Liabilities understated
Increased expenses
Increased liabilties
