Chapter 4 Study Notes - Summary

Chapter 4 Study Notes - Summary - Chapter 4 - Summary Two...

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Chapter 4 - Summary Two main additional journal entries are needed to complete the accounting cycle. First one is an adjusting journal entry , and second one is closing journal entry . Before moving on the adjusting journal entry, I would like to discuss about the two important concepts of the accrual accounting . 1) Revenue recognition principle : Revenues are recorded when following two criteria are met, - The earning process is substantially completed - Cash has been collected or collectivity is reasonably assured 2) Matching principle : Expenses are recorded when the assets or costs are incurred (used up) for generating revenue. The above two principles are applied to recognize revenue or expenses in the following adjusting journal entry. 1. Adjusting journal entries - Why is needed? : To report a correct account balance of the current reporting period. Because some transactions affect current reporting period as well as future reporting period, we have to adjust accounts only for current period. - When: End of the reporting period (Ex: If a company’s fiscal period is the same as calendar year and the reporting period is annual basis, the end of the reporting period is 12/31/XXXX) - How: Two types - “Prepaid” and “Accrual” 1) Type1: “Prepaid (pre-received)” – Prepaid expenses and unearned revenue The prepaid type of transactions must be recorded in original journal entry at the date of cash payment or cash receipt for those cash transactions. a) Prepaid expenses (Assets): Payment made in advance for normally charged to expenses Since prepaid expanses will be used up for generating firm’s revenue, the prepaid expenses ( assets account ) will be recognized as expenses in future (based on matching principle). Ex) On March 1, 2006, Shop Rite paid its insurance agent $3,000 for the premium due on a 24-month corporate policy. Prepare adjusting journal entries at December 31, 2006.
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>>> First of all, we have to report the cash transaction in original entry. Original journal entry 3/1/06 (The date of cash payment) Dr) Prepaid insurance expense (Assets) $ 3,000 Cr) Cash 3,000 At the end of period, 12/31/06, we have to recognize correct expenses and adjust the original journal entry item for current period (2006). Since prepaid insurance account is used up ( incurred/decreased ) to generate firm’s revenue for the period
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Chapter 4 Study Notes - Summary - Chapter 4 - Summary Two...

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