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Chapter 4 - ADJUSTMENTS, FINANCIAL STATEMENTS, and the QUALITY of EARNINGS Overview In this chapter, we emphasize the use of the same analytical tools (journal entries & T-accounts) to understand how the necessary adjustments are analyzed and recorded at the end of the accounting period. We examine the end-of-period steps that focus primarily on adjustments to record revenues and expenses in the proper period and to update the balance sheet accounts for reporting purposes. Finally, we illustrate how to prepare the accounting records for the next period by “closing the books.” Business Background Management is responsible for the financial statements of a company that are used by investors, creditors, and others. The financial statement information should be relevant (timely) and reliable (verifiable and unbiased). The result of this high quality information is useful in analyzing the past and predicting the future. The Accounting Cycle During the period, transactions are analyzed, recorded in journals, and posted to the general ledger. At the end of the period, accounts are analyzed, adjustments are determined, financial statements are prepared, and the books are closed. The closing process clears all temporary accounts to a zero balance so they are ready for the accumulation of amounts in the new period. The Unadjusted Trial Balance The first step at the end of the accounting cycle is to prepare an “unadjusted” trial balance. This is merely a listing of accounts (usually in financial statement order) and their balances. Debit balances are placed in the left money column and credit balances are placed in the right money column. A trial balance is a "try to balance.” It is a schedule for internal purposes to test debit-credit equality. It is NOT a financial statement. There are several reasons for an imbalance to exist Journal entries did not balance Posting errors occurred Computing the balance of an account may have a calculation error. Account balances may have been copied incorrectly to the trial balance. Chapter 4 Review Notes Acc 311 - Page 1
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Adjustments Following the revenue principle (recognition when earned) and the matching principle (recognize when incurred to generate revenues) requires adjustments of revenue and expense accounts. Because many operating activities take place over a period of time, adjustments must be made at the end of the reporting period to record related revenues and expenses in the correct period. Measuring revenue and expense items requires managers to make estimates. Applying sound judgment to estimate and record revenues when earned and expenses when incurred in the proper period is important for providing investors, creditors and other users with reliable income measurement.
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