Explain the revenue recognition principle and the expense recognition principle.2.Differentiate between the cash basis and the accrual basis of accounting.3.Explain why adjusting entries are needed, and 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.Study Objectives
The PeriodicityAssumption requires accountants to divide the economic life of a business into artificial time periods.•Fiscal year vs. calendar yearJan.Feb.Mar.Apr.Dec.. . . . .Timing IssuesCompanies recognize revenue in the accounting period in which it is earned. This is called the RevenueRecognition Principle.•Record revenue in period service provided or goods delivered.•Doesn’t matter when cash is received.Expenses are matched with revenues in the period when efforts are expended to generate revenues. This is called the ExpenseRecognition Principle.•Expenses follow Revenues.•Also called the Matching Principle.
Accrual-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.SO 2 Differentiate between the cash basis and the accrual basis of accounting.Accrual vs. Cash Basis of Accounting
Cash-Basis Accounting•Revenues are recognized only when cash is received.•Expenses are recognized only when cash is paid. •Prohibitedunder generally accepted accounting principles (GAAP).SO 2 Differentiate between the cash basis and the accrual basis of accounting.Accrual vs. Cash Basis of Accounting
ExampleSuppose 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 2012.20112012TotalCash Receipts0 80,00080,000Cash Payments50,000050,000Net Income (Loss)(50,000) 80,00030,000Prepare income statements using the cash basisPrepare income statements using the accrual basisSame in total:
•Adjusting entries make it possible to report correct amounts on the balance sheet and on the income statement.•A company must make adjusting entries every time it prepares financial statements. •Includes one income statement account andone balance sheetaccount.•1 Revenue or Expense•1 Asset or Liability•Needed to ensure that the revenuerecognition and expenserecognition principles are followed.Adjusting Entries
•Deferrals•Prepaid Expenses•Unearned Revenues•Accruals•Accrued Revenue•Accrued ExpensesType depends on when cash is received/paid and revenue/expense is recognized.