Accounting 2000Chapter 4 Notes1.Explain the revenue recognition principle and the expense recognition principle.2.Differentiate between the cash basis and the accrual basis of accounting.3.Identify the major types of adjusting entries.4.Prepare adjusting entries for deferrals.5.Prepare adjusting entries for accruals.6.Describe the nature and purpose of the adjusted trial balance.7.Explain the purpose of closing entries.8.Describe the required steps in the accounting cycle.Timing Issues:The periodicityAssumption requires accountants to divide the economic life of a business into artificial time periods.Companies recognize revenue in the accounting period in which it is earned. This is called the RevenueRecognition Principle.Expenses are matched with revenues in the period when efforts are expended togenerate revenues. This is called the Expense Recognition Principle.Accrual versus Cash Basis of AccountingAccrual-Basis Accounting►Transactions recorded in the periods in which the events occur.►Revenues are recognized when earned, even if cash was not received. ►Expenses are recognized when incurred, even if cash was not paid.Cash-Basis Accounting►Revenues are recognized only when cash is received.►Expenses are recognized only when cash is paid. ►Prohibited under generally accepted accounting principles.Example: Page 1of 10
Accounting 2000Chapter 4 NotesSuppose that Fresh Colors paints a large building in 2011. In 2011, it incurs and pays total expenses (salaries and paint costs) of $50,000. It bills the customer $80,000, but does not receive payment until 2012.Prepare income statements using the cash basis:Income Statement-Cash Basis20112012TotalCash Receipts080,00080,000Cash Payments50,000050,000Net Income (Loss)(50,000)80,00030,000Prepare income statements using the accrual basis:Income Statement-Accrual Basis20112012TotalRevenues80,000080,000Expenses(50,000)0(50,000)Net Income (Loss)30,000030,000 Adjusting Entries•Adjusting entries make it possible to report correct amounts on the balance sheet and on the income statement.