The Adjusting ProcessChapter 3

What is the Difference between Cash Basis Accounting & Accrual Basis Accounting?

• Keep in mind that the accrual basis is the preferred way to do accounting—and it’s required by GAAP.

CASH BASIS• Revenue is

recorded when Cash is received• Expenses are

recorded when Cash is paid• Not allowed under

GAAP

ACCRUAL BASIS• Revenue is

recorded when it is earned• Expenses are

recorded when incurred• Generally used by

larger businesses

Accrual vs. Cash-Basis Accounting

•Recording Accruals

Accounting Period ConceptBusinesses prepare financial statements for specific periods to evaluate performanceBasic accounting period = one year

Calendar yearFiscal year

Interim periodsFinancial statements of less than one year

MonthlyQuarterlySemi-annually

Revenue Recognition PrincipleWhen to record revenue?

When it is earnedWhen service is providedWhen the product deliveredWhen the earnings process is complete

Not when cash is received, accrual methodThe amount of revenue to recorded?

Value of item or service transferred to customer

The Matching PrincipleMeasure all expenses incurred during the periodMatch the expenses against the revenues earned during the same period

The Time-Period ConceptRequires that accounting information be reported at regular intervalsAccounts are updated at the end of each accounting period

Types of Adjusting Entries

Prepaid expenses Depreciation Accrued

expenses

Accrued revenues

Unearned revenues

Types of Adjusting EntriesPrepayments - Advance payments of expensesExamples:

RentInsuranceSupplies

Types of Adjusting Entries•Depreciation

Plant assetsLong-lived tangible assets used in business operationsExamples:

Land, buildings, equipment, and furniture

Types of Adjusting Entries

•Accrued ExpensesExpenses incurred before payment is made

Results in a liabilityOpposite of a prepaid expense

Examples:SalariesInterest

Types of Adjusting Entries

•Accrued RevenuesRevenue earned before cash is received

Types of Adjusting Entries•Unearned Revenue•Cash is collected before revenue is earned

▫Results in a liability ▫Owes a product or service or refund

•Also called deferred revenue

Adjusted Trial BalancePrepared after adjusting entries are postedUseful step in preparing financial statementsOften appears on a work sheet

Tool accountants use at end of period

PREPARING AN ADJUSTED TRIAL BALANCE – Exercise P3-35A (p. 187).

Income Statement