A Further Look at Financial StatementsCHAPTER STUDY OBJECTIVES1.Explain the revenue recognition principle and the matching principle.The revenuerecognition principle dictates that companies recognize revenue in the accounting period inwhich it is earned. The matching principle dictates that companies recognize expenses whenexpenses make their contribution to revenues.2.Differentiate between the cash basis and the accrual basis of accounting.Accrual-based accounting means that companies record in the periods in which the events occurevents that change a company's financial statements. Under the cash basis, companiesrecord events only in the periods in which the company receives or pays cash.3.Explain why adjusting entries are needed and identify the major types of adjustingentries. Companies make adjusting entries at the end of an accounting period. These entriesensure that companies record revenues in the period in which they are earned and thatcompanies recognize expenses in the period in which they are incurred. The major types ofadjusting entries are prepaid expenses, unearned revenues, accrued revenues, and accruedexpenses.4.Prepare adjusting entries for prepayments.Prepayments are either prepaid expenses orunearned revenues. Companies make adjusting entries for prepayments at the statementdate to record the portion of the prepayment that represents the expense incurred or therevenue earned in the current accounting period.5.Prepare adjusting entries for accruals.Accruals are either accrued revenues or accruedexpenses. Adjusting entries for accruals record revenues earned and expenses incurred inthe current accounting period that have not been recognized through daily entries.6.Describe the nature and purpose of the adjusted trial balance. An adjusted trial balanceis a trial balance that shows the balances of all accounts, including those that have beenadjusted, at the end of an accounting period. The purpose of an adjusted trial balance is toshow the effects of all financial events that have occurred during the accounting period.7.Explain the purpose of closing entries.One purpose of closing entries is to transfer theresults of operations for the period to Retained Earnings. A second purpose is to “zero-out” alltemporary accounts (revenue accounts, expense accounts, and dividends) so that they starteach new period with a zero balance. To accomplish this, companies close all temporaryaccounts at the end of an accounting period. They make separate entries to close revenuesand expenses to Income Summary, Income Summary to Retained Earnings, and Dividends toRetained Earnings. Only temporary accounts are closed.