Chapter 4 Flashcards
Accounting time periods
Genearlly a month, quarter, or a year
Fiscal year
An accounting time period that is one year long
Revenue recognition principle
Requires that companies recognize revenue in the accounting period in which it is earned
Expense Recognition Principle
“Matching principle”
Expenses matched with revenues in the period when efforts are expended to generate revenues
Krispy Kreme
Doubled number of donuts to boost quarterly sales
Computer Associates International
Accused of backdating sales
International note: accural basis
Acccrusal basis of accounting is central to all of these standards
Adjusting entries
Ensure that the revenue recognition and expense recognition principles are followed
required every time a company prepares financial statements
Every adjusting entry will include one income statement account and one balance sheet account
trial balance
the first pulling together of the transaction data
International note: internal controls
Internal controls - system of checks and balances designed to detect and prevent fraud and errors
Foreign companies dont have to follow this in SOX
Unfair advantage because developing internal controls is expensive
2 types of deferrals
Prepaid expenses
Unearned revenues
Prepaid expenses or Prepayments
Expenses that will benefit more than one accounting period as assets
Adjusting entry for prepaid expenses
An increase (debit) to a expense account
A decrease (credit) to an asset account
Useful life
The period of service of an asset
Depreciation
The process of allocating the cost of an asset to exepnse over its useful life
Depreciation concept
An allocation concept, not a valuation concept
Allocates an asset’s cost to the periods in which it is used
Does not attempt to report the actual change in the value of the asset
Contra asset account
Accmulated Depreciaition is called this
Helpful hint: contra assets
All contra accounts have increases, decreases, and normal balances opposite to the account to which they relate
Book value
The difference between the cost of any depreciable asset and its related accumulated depreciation
Another term for book value
Carrying value
Adjustment entry for unearned revenues
Results in a decrease (debit) to a liability account
Increase (credit) to a revenue account
Accounting for prepaid expenses
Ex. insurance, supplies
Reason: prepaid expenses recorded in asset accounts have been used
accounts before adjustment: assets overstated/ expenses understated
Adjusting entry: dr. expenses/cr. assets
Accounting for unearned revenues
Ex. rent, magazines
reason: unearned revenues recorded in liability have been earned
before adjustment: liabilities overstated/revenues understated
adjusting entry: dr. liablities/ cr revenues
Adjustment entry for accrued revenues
Increase (debit) to an asset account
Increase (credit) to a revenue account
Accounting for accrued revenues
Ex. rent, services performed but not collected
reason: revenues have been earned but not yet received in cash or recorded
before adjustment: assets understated/revenues understated
adjusting entry: dr. assets / cr. revenues
accrued expenses
Expenses incurred but not yet paid or recorded at the statement date
Adjusting entry for accrued expenses
Results in an increase (debit) to an expense
Increase (credit) to a liability
Fannie Mae’s
Improper adjusting entries resulted in delayed recognition of expense caused by interest-rate changes
motivation: hit earnings estimates
China and accrual accounting
switched from cash to accrual accounting to meet a projected budget deficit goal
Accounting for acccrued expenses
Ex. interest, rent, salries
reason: expenses have been incurred but not yet paid in cash or recorded
before adjustment: expenses understated / liabilities understated
adjusting entry: dr. expenses / cr. liabilities
Prepaid expenses (AE)
dr. expenses
cr. assets
Unearned revenues (AE)
dr. liablities
cr. revenues
accrued revenues (AE)
dr. assets
cr. revenues
accrued expense (AE)
dr. expenses
cr. liabilties
Adjusted trial balance
Purpose: prove the equality of the total debit balances and the total credit balances in the ledger after adjustments
Primary basis for the preparation of financial statements
How do companies prepare financial statements?
Directly from an adjusted trial balance
Temporary accounts
Revenue, expense, and dividend accounts whose balances a company transfers to Retained Earnings at the end of an accounting period
Permanent accounts
Balance sheet accounts whose balances are carried forward to the next accounting period
Other term for temporary accounts
nominal accounts
Other term for permanant accounts
Real accounts
Closing entries
transfer net income and dividends to Retained Earnings, so the balance in Retained Earings agrees with the retained earnings statement
Temporary
All revenue accounts
All expense accounts
Dividends
Permanent
All asset accounts
All liability accounts
Stockholders’ equity accounts
Post-closing trial balance
A list of permanent accounts and their balances after a company has journalized and posted closing entries
Income summary
A temporary account used in closing revenue and expense accounts
Reversing entry
An entry made at the beginning of the next accounting period
The exact opposite of the adjusting entry made in the previous period
Earnings management
The planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income
High Quality of earnings
Full and transparent information that will not confus or mislead users of the financial statements
One time items
Used to prop up earnings numbers
ConAgra foods did this
Inflate revenue
provide larger incentives for people to buy products to meet goals
Bristol-Myers Squibb did this
Improper adjusting entries
A way to manage earnings
