ACCT 2000 Ch 4.docx - Accounting 2000 Chapter 4 Class Notes 1 2 3 4 Explain the accrual basis of accounting and the reason for adjusting entries Prepare

ACCT 2000 Ch 4.docx - Accounting 2000 Chapter 4 Class Notes...

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Accounting 2000 Chapter 4 Class Notes 1. Explain the accrual basis of accounting and the reason for adjusting entries. 2. Prepare adjusting entries for deferrals. 3. Prepare adjusting entries for accruals. 4. Prepare financial statements from adjusted amounts. Timing Issues: The Periodicity Assumption requires accountants to divide the economic life of a business into artificial time periods. Companies recognize revenue in the accounting period in which the performance obligation is satisfied. This is called the Revenue Recognition Principle. (earned) Expenses are matched with revenues in the period when efforts are expended to generate revenues. This is called the Expense Recognition Principle. (owed) Accrual versus Cash Basis of Accounting Accrual-Basis Accounting Transactions recorded in the periods in which the events occur. Revenues are recognized when services are performed, even if cash was not received. (rendered means revenue) Expenses are recognized when incurred, even if cash was not paid. (is GAAP) Cash-Basis Accounting Revenues are recognized only when cash is received. Expenses are recognized only when cash is paid. Prohibited under generally accepted accounting principles (not GAAP). Example: Page 1 of 26
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Accounting 2000 Chapter 4 Class Notes Suppose that Fresh Colors paints a large building in 2019. In 2019, it incurs and pays total expenses (salaries and paint costs) of $50,000. It bills the customer $80,000, but does not receive payment until 2020. Prepare income statements using the cash basis : Income Statement-Cash Basis 2019 2020 Total Cash Receipts 0 $80,000 $80,000 Cash Payments ($50,000) 0 ($50,000) Net Income (Loss) ($50,000) $80,000 $30,000 Prepare income statements using the accrual basis : Income Statement-Accrual Basis 2019 2020 Total Revenues $80,000 0 $80,000 Expenses ($50,000) 0 ($50,000) Net Income (Loss) $30,000 0 $30,000 Adjusting Entries Adjusting entries make it possible to report correct amounts on the balance sheet and on the income statement. A company makes adjusting entries every time it prepares financial statements. Includes one income statement account (rev or exp) and one balance sheet account (asset or liab) Needed to ensure that the Revenue and Expense principles are followed. Page 2 of 26
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Accounting 2000 Chapter 4 Class Notes Types of Adjusting Entries DEFERRALS 1. Expenses paid in cash and recorded as assets before they are used or consumed are called Prepaid Expenses. 2. Cash received and reported as liabilities before revenue is earned are called Unearned Revenue. 1. Prepaid Expenses Examples: Prepaid Insurance, Supplies and Depreciation (Key to Deferral) Costs that expire either with the passage of time or through use Adjusting entry results in an increase to an expense account and a decrease to an asset account. Prepaid Expenses Assets = Liabilities + Stockholders’ Equity Asset Account Revenues - Expenses Decreases Increases Page 3 of 26
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Accounting 2000 Chapter 4 Class Notes Example (Supplies): Sierra Corporation purchased supplies costing $2,500 on October 5. Sierra recorded the purchase by increasing the asset Supplies.
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