Chapter 4 class notes - Accounting 2001 Chapter 4 Notes 1 2...

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Page 1 of 101.2.3.4.5.6.7.Explain the revenue recognition principle and the expense recognition principle.Differentiate between the cash basis and the accrual basis of accounting.Identify the major types of adjusting entries.Prepare adjusting entries for deferrals.Prepare adjusting entries for accruals.Describe the nature and purpose of the adjusted trial balance.Explain the purpose of closing entries.Describe the required steps in the accounting cycle.8.Accounting2001Chapter4NotesTimingIssues:The __periodicity__ Assumption requires accountants to divide the economic life ofa business into artificial time periods.Companies recognize revenue in the accounting period in which it is earned. This iscalled the __revenue__ Recognition 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-BasisAccountingTransactions 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-BasisAccountingRevenues are recognized only when cash is _received_.Expenses are recognized only when cash is __paid_._prohibited_ under generally accepted accounting principles.
20112012TotalCashReceipts080,00080,000CashPayments50,0000(50,000)NetIncome(Loss)(50,000)80,00030,000Example:Suppose that Fresh Colors paints a large building in 2011. In 2011, it incurs and paystotal expenses (salaries and paint costs) of $50,000. It bills the customer $80,000, butdoes not receive payment until 2012.Prepareincomestatementsusingthecashbasis:IncomeStatement-CashBasisPrepareincomestatementsusingtheaccrualbasis:20112012TotalRevenues80,000080,000Expenses(50,000)0(50,000)NetIncome(Loss)30,000030,000Page 2 of 10Accounting2001Chapter4NotesIncomeStatement-AccrualBasisAdjusting EntriesAdjusting entries make it possible to report correct amounts on the balance sheetand on the income statement.A company makes adjusting entries every time it prepares financial statements.

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