الثلاثاء، 22 مارس، 2016

Summarization chapter 3 - adjusting the accounts


Summarization chapter 3 - adjusting the accounts

Timing issues
If we could wait to prepare financial statements until a company ended its operations, no adjustments would be needed. At that point, we could easily determine its final balance sheet and the amount of lifetime income it earned. However, most companies need immediate feedback about how well they are doing. For example, management usually wants monthly financial statements. The Internal Revenue Service requires all businesses to file annual tax returns. Therefore, accountants divide the economic life of a business into artificial time periods. This convenient assumption is referred to as the time period assumption.
Fiscal and Calendar Years
-Both small and large companies prepare financial statements periodically in order to assess their fi nancial condition and results of operations. Accounting time periods are generally a month, a quarter, or a year .
-Monthly and quarterly time periods are called interim periods. Most large companies must prepare
both quarterly and annual financial statements .
-An accounting time period that is one year in length is a fiscal year. A fiscal year usually begins with the first day of a month and ends 12 months later on the last day of a month.
-Most businesses use the calendar year (January 1 to December 31) as their accounting period.

Accrual- versus Cash-Basis Accounting
accrual-basis accounting companies record transactions that change a company’s financial
statements in the periods in which the events occur. For example, using the accrual basis to determine net income means companies recognize revenues when they perform services (rather than when they receive cash). It also means recognizing expenses when incurred (rather than when paid).

cash-basis accounting, companies record revenue when they receive cash. They record an expense when they pay out cash. The cash basis seems appealing due to its simplicity, but it often produces misleading fi nancial statements. It fails to record revenue for a company that has performed services but for which it has not received the cash. As a result, it does not match expenses with revenues. Cashbasis accounting is not in accordance with generally accepted accounting principles (GAAP)


Recognizing Revenues and Expenses
(matching principle). It dictates that efforts (expenses) be matched with results (revenues).
REVENUE RECOGNITION PRINCIPLE
When a company agrees to perform a service or sell a product to a customer, it has a performance obligation. When the company meets this performance obligation, it recognizes revenue. The revenue recognition principle therefore requires that companies recognize revenue in the accounting period in which the performance obligation is satisfied
EXPENSE RECOGNITION PRINCIPLE
Accountants follow a simple rule in recognizing expenses: “Let the expenses follow the revenues.” Thus, expense recognition is tied to revenue recognition
-The critical issue in expense recognition is when the expense makes its contribution to revenue. This may or may not be the same period in which the expense is paid. If Dave’s does not pay the salary
incurred on June 30 until July, it would report salaries payable on its June 30 balance sheet


The Basics of Adjusting Entries


In order for revenues to be recorded in the period in which services are performed and for expenses to be recognized in the period in which they are incurred, companies make adjusting entries. Adjusting entries ensure that the revenue recognition and expense recognition principles are followed.

Adjusting entries are required every time a company prepares financial statements. The company analyzes each account in the trial balance to determine whether it is complete and up to date for financial statement purposes. Every adjusting entry will include one income statement account and one balance sheet account .

Types of Adjusting Entries
Adjusting entries are classified as either deferrals or accruals

Deferrals: (المؤجل مثل المصروف المقدم مؤجل الاعتراف به والايراد الغير مكتسب  مؤجل الاعتراف به)
1. Prepaid expenses: Expenses paid in cash before they are used or consumed.
2. Unearned revenues: Cash received before services are performed.
3.DEPRECIATION is the process of allocating the cost of an asset to expense over its useful life
Accruals: 
1. Accrued revenues: Revenues for services performed but not yet received in cash or recorded.
2. Accrued expenses: Expenses incurred but not yet paid in cash or recorded.
Adjusting Entries for Deferrals
Deferrals are expenses or revenues that are recognized at a date later than the point when cash was originally exchanged. 

*When companies record payments of expenses that will benefit more than one accounting period, they record an asset called prepaid expenses or prepayments. When expenses are prepaid, an asset account is increased (debited) to show the service or benefit that the company will receive in the future. Examples of common prepayments are insurance

*At each statement date, they make adjusting entries to record the expenses applicable to the current accounting period and to show the remaining amounts in the asset accounts.




*When companies receive cash before services are performed, they record a liability by increasing (crediting) a liability account called unearned revenues. In other words, a company now has a performance obligation (liability) to transfer a service to one of its customers. Items like rent, magazine subscriptions, and customer deposits for future service may result in unearned revenues

Adjusting Entries for accruals
ACCRUED REVENUES
Revenues for services performed but not yet recorded at the statement date are accrued revenues.



ACCRUED EXPENSES

Expenses incurred but not yet paid or recorded at the statement date are called accrued expenses. Interest, taxes, and salaries are common examples of accrued expenses.


Summary of Basic Relationships



The Adjusted Trial Balance and Financial Statements


After a company has journalized and posted all adjusting entries, it prepares another trial balance from the ledger accounts. This trial balance is called an adjusted trial balance. It shows the balances of all accounts, including those adjusted, at the end of the accounting period. The purpose of an adjusted trial balance is to prove the equality of the total debit balances and the total credit balances in the ledger after all adjustments. Because the accounts contain all data needed for fi nancial statements, the adjusted trial balance is the primary basis for the preparation of fi nancial statements.

Companies can prepare financial statements directly from the adjusted
trial balance









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