SM_Chap004

Fundamentals of Financial Accounting with Annual Report

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Chapter 04 - Adjustments, Financial Statements, and Financial Results Chapter 4 Adjustments, Financial Statements, and Financial Results ANSWERS TO QUESTIONS 1. Adjusting entries are made at the end of the accounting period to record all revenues and expenses that have not been recorded but belong in the current period. These adjustments also ensure that the related accounts on the balance sheet and income statement are up-to-date and complete. 2. (a) The time period assumption states that the long life of a company can be divided into shorter time periods. Adjustments are required by GAAP to ensure that a company’s financial statements include all the transactions of the given time period. (b) The revenue principle states that revenues should be recorded when earned. Adjustments assist in recording revenues during the period in which they are earned, rather than when cash is received. (c) The matching principle states that expenses are recorded when incurred to generate revenues. Adjustments ensure that the expenses incurred during a particular period are, in fact, recorded during that period. 3. The two different types of adjusting journal entries are: (1) Deferral adjustments: (a) Revenues -- previously recorded liabilities that need to be adjusted at the end of the period to reflect earned revenues (e.g., unearned revenue must be adjusted for the portion of sales revenues earned in the current period). (b) Expenses-- previously recorded assets that need to be adjusted at the end of the period to reflect incurred expenses (e.g., prepaid insurance must be adjusted for the portion of insurance expense incurred in the current period). (2) Accrual adjustments: (a) Revenues -- revenues that have been earned by the end of the accounting period but which will be collected in a future accounting period (e.g., recording interest receivable for interest earned but not yet collected). (b) Expenses -- expenses that have been incurred by the end of the accounting period but which will be paid in a future accounting period (e.g., recording an accrued liability for utilities used during the period but which have not yet been paid). 4-1
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Chapter 04 - Adjustments, Financial Statements, and Financial Results 4. Adjusting entries have no effect on cash. For unearned revenues and prepayments, cash was received or paid at some point in the past. For accruals, cash will be received or paid in a future accounting period. At the time of the adjusting entry, no cash is received or paid. 5. A contra-asset is an account related to an asset that is an offset or reduction to the asset's balance. Accumulated Depreciation is a contra-account to the equipment and buildings accounts. 6. Depreciation expense is reported on the income statement. It indicates the amount of depreciation for the current period. Accumulated depreciation is reported on the balance sheet (as a contra-asset). It indicates the total depreciation, accumulated from the date the asset was acquired to the date of the balance sheet.
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