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o b j e c t i v e s 3 THE MATCHING CONCEPT AND THE ADJUSTING PROCESS After studying this chapter, you should be able to: 1 Explain how the matching concept relates to the accrual basis of accounting. 2 Explain why adjustments are neces- sary and list the characteristics of adjusting entries. 3 Journalize entries for accounts requir- ing adjustment. 4 Summarize the adjustment process and prepare an adjusted trial balance. 5 Use vertical analysis to compare finan- cial statement items with each other and with industry averages. PHOTO: © PHOTODISC GREEN/GETTY IMAGES 66124_c03_101-138.qxd 11/10/03 8:06 PM Page 101
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A T A ssume that you rented an apartment last month and signed a nine-month lease. When you signed the lease agreement, you were required to pay the final month’s rent of $500. This amount is not returnable to you. You are now applying for a student loan at a local bank. The loan application re- quires a listing of all your assets. Should you list the $500 deposit as an asset? The answer to this question is “yes.” The deposit is an asset to you until you re- ceive the use of the apartment in the ninth month. A business faces similar accounting problems at the end of a period. A business must determine what assets, liabilities, and owner’s equity should be reported on its balance sheet. It must also determine what revenues and expenses should be reported on its income statement. As we illustrated in previous chapters, transactions are normally recorded as they take place. Periodically, financial statements are prepared, summarizing the effects of the transactions on the financial position and operations of the business. At any one point in time, however, the accounting records may not reflect all trans- actions. For example, most businesses do not record the daily use of supplies. Like- wise, revenue may have been earned from providing services to customers, yet the customers have not been billed by the time the accounting period ends. Thus, at the end of the period, the revenue and receivable accounts must be updated. In this chapter, we describe and illustrate this updating process. We will focus on accounts that normally require updating and the journal entries that update them. When accountants prepare financial statements, they assume that the eco- nomic life of the business can be di- vided into time periods. Using this accounting period concept , ac- countants must determine in which period the revenues and expenses of the business should be reported. To determine the appropriate period, ac- countants will use either (1) the cash basis of accounting or (2) the accrual basis of accounting. Under the cash basis , revenues and expenses are reported in the income state- ment in the period in which cash is received or paid. For example, fees are recorded when cash is received from clients, and wages are recorded when cash is paid to employees. The net income (or net loss) is the difference between the cash receipts (revenues) and the cash payments (expenses).
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