Topic 4 - Recording Business Transactions: Accrual Accounting Adjustments Flashcards

1
Q

What are the 4 accrual accounting adjustments?

A
  1. Unearned Revenue
  2. Prepayment
  3. Accrued Revenue
  4. Accrued Expense
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2
Q

What is Unearned Revenue? and when is the revenue recognised?

A
  • Cash Received in advance of earning revenue

- The revenue is not recognised until the good or service is provided and will be seen as a liability

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3
Q

What is a Prepayment? and when is the expense recognised?

A
  • Cash given before a good or service has been provided to you
  • The expense is not recognised until the good or service is provided and will be seen as an asset
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4
Q

What is Accrued Revenue?(2)

A
  • Cash Received after you provide a good or service

- Seen as a type of account receivable (asset)

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5
Q

What is Accrued Expense?(2)

A
  • Cash paid after you receive a good or service

- Seen as a type of account payable (liability)

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6
Q

How are these adjustments accounted for in journal entries?(2)

A

With two entries for each half of the transaction
• One for the payment (holding area for incomplete revenue and expense transactions)
• One for the transaction (transaction completed)

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7
Q

What is the downside to accrual accounting adjustment factors?

A

Mechanism for manipulating results and producing misleading reports as accrual adjustments are subjective.

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8
Q

What is Earnings Management?

A

Earnings management: the use of accounting techniques to produce financial statements that present an overly positive (or negative) view of a company’s business activities and financial position.

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9
Q

What is GAAP?(2)

A
  • GAAP = generally accepted accounting principles

- Rules, standards, and usual practices that companies are expected to follow when preparing financial statements.

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10
Q

What is the GAAP?(3)

A
  • Accounting Standards
  • The Framework(rules)
  • Additional rules (for specific situations)
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11
Q

What does the GAAP framework contain?(4)

A
  • Objectives of financial reports (Why we need financial accounting)
  • Assumptions underlying financial reports
  • Qualitative characteristics of financial information
  • Definition of elements of financial statements E. Recognition and measurement of those elements
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12
Q

How does Earnings management take place?

A

By taking advantage of how accounting rules are applied and create financial statements that “inflate” or “smooth” earnings (revenue or profitability)

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13
Q

Why would companies manage their earnings?(4)

A
  • Market pressure to meet financial expectations
  • Bonus dependent on certain revenue or profitability
  • Senior management pressuring individual managers to improve performance (Bad company culture)
  • Culture of company demands ‘high-growth’
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14
Q

In what ways can a company manage earnings?(6)

A
  • Improper recognition of revenue
  • Recording fictitious revenue
  • Channel stuffing (Credit sales)
  • Improper management salary estimates
  • Improper capitalization of expenses
  • Improper expense recognition
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15
Q

What are the risks of earnings Management

A

Users of these financial statements are not basing their decision making on ‘true and fair’ information.

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16
Q

How is earnings management identified or stopped?(2)

A
  • Audit

- internal controls