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Monday, January 18, 2010

Adjusting The Accounts

Accrual- vs. Cash-Basis Accounting

Accrual-Basis Accounting

  1. Transactions recorded in the periods in which the events occur
  2. Revenues are recognized when earned, rather than when cash is received.
  3. Expenses are recognized when incurred, rather than when paid.

Cash-Basis Accounting

  1. Revenues are recognized when cash is received.
  2. Expenses are recognized when cash is paid.
  3. Cash-basis accounting is not in accordance with generally accepted accounting principles (GAAP).

The Basics of Adjusting Entries
  1. Adjusting entries make it possible to report correct amounts on the balance sheet and on the income statement.
  2. A company must make adjusting entries every time it prepares financial statements.
  3. Revenues - recorded in the period in which they are earned.
  4. Expenses - recognized in the period in which they are incurred.
  5. Adjusting entries - needed to ensure that the revenue recognition and matching principles are followed.

Deferrals are either:

  1. Prepaid expenses or
  2. Unearned revenues.

Prepaid Expenses
  1. Costs that expire either with the passage of time or through use.
  2. Adjusting entries (1) to record the expenses that apply to the current accounting period, and (2) to show the unexpired costs in the asset accounts.

  1. Buildings, equipment, and vehicles (long-lived assets) are recorded as assets, rather than an expense, in the year acquired.
  2. Companies report a portion of the cost of a long-lived asset as an expense (depreciation) during each period of the asset’s useful life (Matching Principle).

Depreciation (Statement Presentation)

  1. Accumulated Depreciation—is a contra asset account.
Appears just after the account it offsets (Equipment) on the balance sheet.

Unearned Revenues
  1. Company makes an adjusting entry to record the revenue that has been earned and to show the liability that remains.
  2. The adjusting entry for unearned revenues results in a decrease (a debit) to a liability account and an increase (a credit) to a revenue account.

Adjusting Entries for Accruals

Made to record:

  1. Revenues earned and
  2. Expenses incurred

In the current accounting period that has not been recognized through daily entries.

Accrued Revenues

An adjusting entry serves two purposes:

(1) It shows the receivable that exists, and

(2) It records the revenues earned.

Accrued Expenses

An adjusting entry serves two purposes:

(1) It records the obligations, and (2) It recognizes the expenses.

The Adjusted Trial Balance

After all adjusting entries are journalized and posted the company prepares another trial balance from the ledger accounts (Adjusted Trial Balance).

Its purpose is to prove the equality of debit balances and credit balances in the ledger.

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