ch04 - CHAPTER 4 Accrual Accounting Concepts CHAPTER...

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CHAPTER 4 Accrual Accounting Concepts CHAPTER OVERVIEW In Chapter 4 you will learn about two generally accepted accounting principles, the revenue recognition principle and the matching principle. You will learn about differences between the cash basis and the accrual basis of accounting. The chapter will explain what adjusting journal entries are, why they are needed, and how to prepare them. Finally, you will learn how to prepare an adjusted trial balance and closing journal entries, as well as the different steps in the accounting cycle. REVIEW OF SPECIFIC STUDY OBJECTIVES SO1. Explain the revenue recognition principle and the matching principle. ¿ Accounting divides the economic life of a business into artificial time periods , generally a month, a quarter, or a year. Some business transactions affect more than one accounting period, and it is necessary to consider a transaction's impact on the affected periods. ¿ The revenue recognition principle states that revenue is to be recognized in the accounting period in which it is earned . (To "recognize" means to record in a journal entry.) For a service firm, revenue is earned at the time that the service is performed , which may or may not be the time at which cash is received. A firm may perform services for a client and receive in return the client's promise to pay the firm in the future. ¿ The matching principle states that expenses (efforts) must be matched with revenues (accomplishments) . This means the following: if a company performs services and thus earns revenue in a given accounting period, then any expenses which helped the company earn the revenue must be recorded in that same accounting period. The critical
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Kimmel Accounting: Tools for Business Decision Making 4-2 issue is determining when the expense makes its contribution to revenue . The principle is easy to state but sometimes difficult to implement. SO2. Differentiate between the cash basis and the accrual basis of accounting. ¿ Accrual basis accounting , resulting from application of the revenue recognition and matching principles, means that transactions that change a company's financial statements are recorded in the periods in which the events occur , rather than in the periods in which the company receives or pays cash. ¿ With cash basis accounting , revenue is recorded only when cash is received, and an expense is recorded only when cash is paid . Because of its potential for violating the revenue recognition and matching principles, the cash basis of accounting does not satisfy generally accepted accounting principles . ¿ A new business often uses the cash basis of accounting because of its simplicity, but eventually it will have to change to the accrual basis. The change requires extensive adjustment to the business's accounting records. SO3.
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ch04 - CHAPTER 4 Accrual Accounting Concepts CHAPTER...

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