Financial Accounting 1 - Adjusting the Accounts

Flashcards covering key concepts from Topic 3: Adjusting the Accounts, including time period assumption, accrual vs. cash basis accounting, adjusting entries, deferrals, accruals, and the adjusted trial balance.

What is the time period assumption?

Accountants divide the economic life of a business into artificial time periods, such as a month, a quarter, or a year.

What is the difference between a fiscal year and a calendar year?

A fiscal year is any 12-month period, while a calendar year runs from January 1 to December 31.

What is accrual-basis accounting?

Transactions are recorded in the periods in which the events occur; revenues are recognized when earned, and expenses are recognized when incurred, regardless of when cash is received or paid.

What is cash-basis accounting?

Revenues are recognized when cash is received, and expenses are recognized when cash is paid. It is not in accordance with GAAP.

What does the revenue recognition principle state?

Companies recognize revenue in the accounting period in which it is earned.

What does the matching principle state?

Match expenses with revenues in the period when the company makes efforts to generate those revenues.

Why are adjusting entries necessary?

To report correct amounts on the balance sheet and income statement and to ensure the revenue recognition and matching principles are followed.

What are the four types of adjusting entries?

Prepaid Expenses, Unearned Revenues, Accrued Revenues, and Accrued Expenses.

What are deferrals?

Prepaid expenses or unearned revenues; cash has been exchanged but the revenue or expense has not yet been recognized.

What are accruals?

Accrued revenues or accrued expenses; the revenue or expense has been recognized but cash has not yet been exchanged.

What is a prepaid expense?

Expenses paid in cash and recorded as assets before they are used or consumed.

What is a potential example of a prepaid expense adjusting entry?

Debit Insurance Expense, Credit Prepaid Insurance.

What is depreciation?

The allocation of the cost of a long-lived asset to expense over its useful life.

What type of account is Accumulated Depreciation?

A contra asset account.

What is an unearned revenue?

Revenues received in cash and recorded as liabilities before they are earned.

What is the effect of the adjusting entry for unearned revenues?

Decrease (debit) to a liability account and an increase (credit) to a revenue account.

What are accrued revenues?

Revenues earned but not yet received in cash or recorded.

What is the effect of the adjusting entry for accrued revenues?

Increases (debits) an asset account (receivable) and increases (credits) a revenue account.

What are accrued expenses?

Expenses incurred but not yet paid in cash or recorded.

What is the effect of the adjusting entry for accrued expenses?

Increases (debits) an expense account and increases (credits) a liability account (payable).

What is the purpose of the adjusted trial balance?

To prove the equality of debit balances and credit balances in the ledger after all adjusting entries are journalized and posted.

Where are financial statements prepared from?

The Adjusted Trial Balance.