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ACCT 201 Chapter 3 Summary

Chapter 3 discusses the importance of adjusting accounts in accounting, emphasizing the time period assumption and the differences between accrual-basis and cash-basis accounting. It explains the revenue recognition and expense recognition principles, as well as the necessity of adjusting entries to ensure accurate financial reporting. The chapter also details types of adjusting entries, including deferrals and accruals, and their respective processes for prepaid expenses, unearned revenues, accrued revenues, and accrued expenses.

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9 views

ACCT 201 Chapter 3 Summary

Chapter 3 discusses the importance of adjusting accounts in accounting, emphasizing the time period assumption and the differences between accrual-basis and cash-basis accounting. It explains the revenue recognition and expense recognition principles, as well as the necessity of adjusting entries to ensure accurate financial reporting. The chapter also details types of adjusting entries, including deferrals and accruals, and their respective processes for prepaid expenses, unearned revenues, accrued revenues, and accrued expenses.

Uploaded by

maddisonrorex1
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Chapter 3: Adjusting the Accounts

Time Period Assumption: the economic life of a business is divided into artificial time periods
(month, quarter, year, etc.); this is appropriate so companies have a frequent, consistent basis on
which to report results of their activities.

• Fiscal Year: accounting period that is one year in length beginning any day other than
January 1
• Calendar Year: an accounting period that begins on January 1 and ends on December 31

Accrual-basis accounting: recording transactions in the period in which the events occur (i.e.:
recording revenues when earned and expenses when incurred regardless of when cash is received
or paid); this is required by GAAP.

Cash-basis accounting: recording revenues when cash is received and recording expenses when
cash is paid regardless of when the event occurred; GAAP does not allow this type of
accounting.

Revenue recognition principle: revenue must be recorded during the period in which it is
earned (when the service is provided or the good is sold).

Expense recognition principle (aka matching principle): expenses should be recorded during
the period they are incurred in order to match the expenses with the revenues.

Adjusting entries: entries to adjust account balances to their correct balances at the end of the
period.

• This ensures that the revenue recognition principle and matching principle are followed
(i.e.: so that all revenue that has been earned and all expenses that have been incurred
during the period are recorded during the period)
• Adjusting entries are made at the end of the period after the trial balance has been
prepared
• Each adjusting entry effects a balance sheet account and an income statement account;
Cash will never be debited or credited in an adjusting entry

Types of adjusting entries: deferrals and accruals

a. Deferrals: when cash is exchanged before revenue is earned or expense is


incurred; two types of deferrals – Prepaid Expenses & Unearned Revenues
b. Accruals: when revenue is earned or expense is incurred before cash is
exchanged; two types of accruals – Accrued Revenue & Accrued Expenses
Deferrals:

1. Prepaid Expenses: cash payments made in advance and recorded as assets before service
or benefit is received.
• The adjusting entry always includes a debit to the expense and a credit to the asset
to show how much of the asset has been used up during the period.
• Examples of prepaid expenses: prepaid insurance, supplies, prepaid rent, fixed
assets
• Depreciation: allocation of the cost of a long-lived asset (also called fixed assets
or property, plant and equipment; examples include building, vehicle, equipment,
etc.) over the asset’s useful life (expected service term). Depreciation is just an
estimate of how much of the fixed asset the company has used during the period.
Example: company purchases a vehicle on 1/1/18 for $25,000 with an expected
useful life of 5 yrs and no salvage value – depreciation expense for 2018 would be
$5,000 (25,000/5 yrs)
• Accumulated Depreciation: contra-asset account which offsets the fixed asset
account it’s depreciating. Its balance represents the total cumulative depreciation
recorded since the asset was acquired. NOTE: THIS IS AN EXCEPTION TO
THE “DEAD” ACRONYM – this is an asset account with a normal credit
balance, meaning it increases with a credit and decreases with a debit
2. Unearned Revenues: liability accounts created when companies receive cash before
earning the revenue.
• At the end of the period, some of the unearned revenues may have been earned
requiring an adjusting entry
• The adjusting entry will always include a debit to liability (unearned revenue) and
a credit to revenue to show how much of the revenue has been earned

Accruals:

1. Accrued Revenues: revenues earned but not yet recorded at the end of the period; an
adjusting entry would debit a receivable and credit a revenue
2. Accrued Expenses: expenses incurred but not yet paid or recorded at the statement date;
common examples include interest, taxes and salaries; an adjusting entry would include a
debit to expense and a credit to liability

Accrued Interest:

Interest = principal * rate * time NOTE: When solving for interest, the time factor is in
terms of one year. If you’re computing interest expense for 1 month, the time factor would be
1/12 (one month out of the year); if you’re computing it for a quarter, it would be 3/12; if you’re
computing it for a year, it would just be 1.
Adjusted Trial Balance: trial balance prepared after adjusting entries are journalized and
posted.

• Just like the trial balance, the adjusted trial balance’s purpose is to show that debits =
credits
• The adjusted trial balance is used to prepare financial statements

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