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ORIE 3150 september 10 notes

ORIE 3150 september 10 notes - ORIE 3150 Adjusting and...

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ORIE 3150 September 10, 2009 Adjusting and Closing Entries 1. Revenue recognition issue: when should a revenue transaction be recorded? Revenue is realized and recorded when all of the following criteria are met: i. Persuasive evidence - This is generally some sort of purchase agreement or contract. It should follow standard practice, and standard policies should be in place and followed. Exceptional treatment is not dealt with lightly. ii. Delivery - Delivery of the goods to the buyer has occurred or the services have been rendered. A customer that makes a buy and hold arrangement (where the seller retains physical possession of the goods until the buyer needs them) with the seller would have to satisfy very detailed and specific requirements. In most cases, delivery to the buyer must be made and the legal title or all risks and benefits of ownership have been transferred to the buyer. iii. Determined Price - The seller's price to the buyer is fixed or determinable. For example, support fees can be roughly estimated upon sale of a product (e.g., for a computer or telecommunication system), but this is generally not precise enough, and revenue recognition should be delayed. iv. Collectibility - Collectibility is reasonably assured. While certainly sale on account is recognized as revenue, other arrangements (such as a small deposit, with payments to be made at unspecified, future time) would not meet this requirement. Fixed dates are better (like net 30 terms for accounts receivable). 2. Accrual Basis - In accounting using the accrual basis, we recognize revenue according to the rules above. In accounting using the cash basis, the transaction is recognized when cash changes hands, not before. Individuals and some businesses (e.g., professional firms) may use the cash basis when computing their taxes. We will use the accrual basis. 3. Valuation - Transactions should be recorded at their original cost or historical cost. 4. Classification - Should the purchase of an item be regarded as a capital expenditure (long term asset) or an expense? Usually, some sort of policy or rules are put in place. E.g., Greater than $1500 = capitalized, less than $1500 = expense.
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5. Matching Rule - We want to record revenues during the same time period as the expenses incurred to earn them. Hence, we use accrual accounting and record expenses when they are incurred and revenues when they are earned. The timing of cash outflows or inflows is irrelevant! Accrual accounting consists of all techniques used to apply the matching rule. When revenue is recorded before cash is received, a receivable is also recorded.
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