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Unformatted text preview: CHAPTER 4 ACCRUAL ACCOUNTING CONCEPTS CHAPTER STUDY OBJECTIVES 1. Explain the revenue recognition principle and the expense recognition principle. The revenue recognition principle dictates that companies recognize revenue in the accounting period in which it is earned. The expense recognition principle dictates that companies recog- nize expenses when expenses make their contribution to revenues. 2. Differentiate between the cash basis and the accrual basis of accounting. Under the cash basis, companies record events only in the periods in which the company receives or pays cash. Accrual-based accounting means that companies record in the periods in which the events occur, events that change a company's financial statements. 3. Explain why adjusting entries are needed, and identify the major types of adjusting entries. Companies make adjusting entries at the end of an accounting period. These entries ensure that companies record revenues in the period in which they are earned and that com- panies recognize expenses in the period in which they are incurred. The major types of adjust- ing entries are prepaid expenses, unearned revenues, accrued revenues, and accrued ex- penses. 4. Prepare adjusting entries for deferrals. Deferrals are either prepaid expenses or unearned revenues. Companies make adjusting entries for deferrals at the statement date to record the portion of the deferred item that represents the expense incurred or the revenue earned in the current accounting period. 5. Prepare adjusting entries for accruals. Accruals are either accrued revenues or accrued expenses. Adjusting entries for accruals record revenues earned and expenses incurred in the current accounting period that have not been recognized through daily entries. 6. Describe the nature and purpose of the adjusted trial balance. An adjusted trial balance is a trial balance that shows the balances of all accounts, including those that have been ad- justed, at the end of an accounting period. The purpose of an adjusted trial balance is to show the effects of all financial events that have occurred during the accounting period. 7. Explain the purpose of closing entries. One purpose of closing entries is to transfer net in- come or net loss for the period to Retained Earnings. A second purpose is to zero-out all temporary accounts (revenue accounts, expense accounts, and dividends) so that they start each new period with a zero balance. To accomplish this, companies close all temporary ac- counts at the end of an accounting period. They make separate entries to close revenues and expenses to Income Summary, Income Summary to Retained Earnings, and Dividends to Re- tained Earnings. Only temporary accounts are closed....
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