Topic 4 - Recording Business Transactions: Accrual Accounting Adjustments Flashcards
What are the 4 accrual accounting adjustments?
- Unearned Revenue
- Prepayment
- Accrued Revenue
- Accrued Expense
What is Unearned Revenue? and when is the revenue recognised?
- 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
What is a Prepayment? and when is the expense recognised?
- 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
What is Accrued Revenue?(2)
- Cash Received after you provide a good or service
- Seen as a type of account receivable (asset)
What is Accrued Expense?(2)
- Cash paid after you receive a good or service
- Seen as a type of account payable (liability)
How are these adjustments accounted for in journal entries?(2)
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)
What is the downside to accrual accounting adjustment factors?
Mechanism for manipulating results and producing misleading reports as accrual adjustments are subjective.
What is Earnings Management?
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.
What is GAAP?(2)
- GAAP = generally accepted accounting principles
- Rules, standards, and usual practices that companies are expected to follow when preparing financial statements.
What is the GAAP?(3)
- Accounting Standards
- The Framework(rules)
- Additional rules (for specific situations)
What does the GAAP framework contain?(4)
- 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
How does Earnings management take place?
By taking advantage of how accounting rules are applied and create financial statements that “inflate” or “smooth” earnings (revenue or profitability)
Why would companies manage their earnings?(4)
- 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’
In what ways can a company manage earnings?(6)
- Improper recognition of revenue
- Recording fictitious revenue
- Channel stuffing (Credit sales)
- Improper management salary estimates
- Improper capitalization of expenses
- Improper expense recognition
What are the risks of earnings Management
Users of these financial statements are not basing their decision making on ‘true and fair’ information.
