Leaming Objective 1 - Explain the Accrual Basis of Accounting and the Reasons for Adjusting Entries Determining the amount of revenues and expenses to report in a given accounting period can be difficult Accounting divides the economic life of a business into artificial time periods. This is the assumption Many transactions affect more than one of these periods. Determining the amount of revenues and expenses to report in a given accounting period can be difficult Proper reporting requires an understanding of the nature of the company's business Two principles are used as guidelines: o Revenue recognition principle o Expense recognition principle The recognition principle requires that revenue be recognized in the accounting period in which the obligation is satisfied. When a company agrees to perform a service or sell a product to a customer, it has created a performance obligation A service company recognizes (records) revenue when the services are The recognition principle requires that efforts (expenses) be with accomnlichmonte (vavannen The recognition principle requires that efforts (expenses) be with accomplishments (revenues). _-basis accounting means that transactions that change a firm's financial statements are recorded in the periods in which the events occur, even if cash was not exchanged. With basis accounting, is recognized (recorded) when cash is received Expenses are recognized (recorded) only when cash is paid. Accrual basis accounting requires accountants to adhere to the recognition principle and the recognition principle. Cash basis accounting does satisfy the requirements of Generally Accepted Accounting Principles (GAAP), whereas accrual basis accounting does. Accrual basis accounting provides an objective measurement of net income. Chapter 4 Outline (1) (Protected view) - Word (Unlicensed Product References Mailings Review View Help Tell me what you want to do om the Internet can contain viruses. Unless you need to edit, it's safe to stay in Protected View. Enable Editing of Word have been disabled Reactivate e a quick edit before renewing your subscription learn more about the Office Web Apps. Learn More entries are needed to ensure that the revenue recognition and expense recognition principles are The trial balance may not contain up-to-date and complete data for several reasons Some events are not recorded daily because it is not efficient to do so. 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 Some items may be unrecorded . Adjusting entries are every time a company prepares financial statements Every adjusting entry will include one income statement account and one balance sheet account Adjusting entries can be classified as either or Each of these classes has two subcategories Deferrals can be prepaid expenses or uneamed revenues. Accruals are either accrued revenues or accrued expenses. Learning Objective 2 - Prepare Adjusting Entries for Deferrals Learning Objective 2 - Prepare Adjusting Entries for Deferrals and Deferrals fall into two categories-prepaid revenues. Prepaid expenses - expenses paid in cash and recorded as assets until they are used Prepaid expenses are costs that expire with the passage of (i. e. rent and insurance) or through use (i. e. supplies). or Unearned services are performed. - cash received and recorded as liabilities before the An adjusting entry for prepaid expenses will result in an increase (a debit) to an account and a decrease (a credit) to an account An adjusting entry for unearned revenues will result in a (a debit) to a liability account and an (a credit) to a revenue account. An adjusting entry for (prepaid expenses or unearned revenues) will decrease a balance sheet account and increase an income statement account Learning Objective 3 - Prepare Adjusting Entries for Accruals Accruals fall into two categories-accrued and accrued Accrued revenues - revenues for services performed but not yet in cash or recorded at the statement date. an adjusting entry for accrued revenues will result in an increase (a debit) in an account and an increase (a credit) to a account . Accrued expenses expenses incurred but not yet in cash or recorded at the statement date. an adjusting entry for accrued expenses results in an increase (a debit) to an account and an increase (a credit) to a account. an adjusting entry for accruals (accrued revenues or accrued expenses) increases both a and an account. Summary of basic relationships: Type of Adjustment Accounts Before Adjustment Adjusting Entry Prepaid expenses Assets overstated Dr. Expenses Expenses understated Cr Assets Unearned revenues Liabilities overstated Dr. Liabilities Revenues understated Cr Revenues Accrued revenues Assets understated Dr. Assets Revenues understated Cr. Revenues Accrued expenses Expenses understated Dr. Expenses Liabilities understated Cr. Liabilities Learning Objective 4 - Prepare an Adjusted Trial and Closing Entries The trial balance is prepared after all adjusting entries have been journalized and posted. The adjusted trial balance shows the balances of all accounts, including those that have been at the end of the accounting period. The purpose of the adjusted trial balance is to prove the of the total debit balances and total credit balances in the ledger after all adjustments Financial statements are prepared from the entries transfer net income (or net loss) and dividends to Retained Earnings This causes the ending balance of (amount shown on the Balance Sheet) to agree with the balance shown on the Retained Earnings Statement Close the revenue accounts to the account Close the accounts to the Income Summary account Close the Income Summary account to Close to Retained Earnings. Closing entries produce a zero balance in each account (revenues, expenses, and dividends) . These accounts are then ready to accumulate data for the next accounting period accounts (assets, liabilities, common stock and retained earnings) are not closed. After the closing entries have been journalized and posted, a. trial balance is prepared . The post-closing trial balance shows the balances of all of the accounts The permanent account balances are carried forward to the next period