Chapter 4: Adjustments, Financial Statements, and Financial Results - Vocabulary

Accounting systems record most recurring daily cash transactions, but cash timing often differs from when revenue is earned or expenses are incurred. Adjustments are made at period end to reflect assets, liabilities, revenues, and expenses at proper amounts.
Revenue recognition: revenues are recorded when the seller satisfies its performance obligation; expenses are recorded when the related assets are consumed or liabilities incurred to generate revenue.
Balance sheet focus: assets reflect remaining economic benefits; liabilities reflect current obligations.

$\text{Assets} = \text{Liabilities} + \text{Stockholders' Equity}$

A deferral adjustment defers recognition of an expense or revenue to a later period.
Effect: decreases a balance sheet account and increases the related income statement account.
Involves one asset and one expense, or one liability and one revenue.

An accrual adjustment records revenue earned or expense incurred in the current period before cash is received or paid.
Effect: adjusts the relevant balance sheet accounts and income statement accounts.
Involves one asset and one revenue account, or one liability and one expense account.

Adjustments are not made daily; they are completed at period end for efficiency.
Steps: analyze necessary adjustments → record adjusting journal entries (AJEs) → summarize in T-accounts → prepare an adjusted trial balance → prepare financial statements → close temporary accounts.

Always analyze unadjusted balances to determine required AJEs.
Deferral AJEs move amounts from balance sheet to income statement; accrual AJEs move in the opposite direction as needed.
Each AJE affects exactly one balance sheet account and one income statement account.
After posting AJEs, adjust balances are used to prepare the adjusted trial balance.
Example themes (from Exhibit references):
- a) Supplies used
- b) Rent expired / prepaid rent used up
- c) Depreciation of equipment
- d) Amortization of software
- e) Gift cards redeemed
- f) Services performed but not yet billed
- g) Wages incurred but not yet paid
- h) Interest incurred but not yet paid
- i) Income taxes incurred but not yet recorded

After all AJEs, prepare the adjusted trial balance listing all accounts with updated debit and credit balances.
Totals must still balance (debits = credits).
Used to derive financial statements.
Note: AJEs never involve cash; they adjust balance sheet and income statement accounts only.

Income Statement: Revenues and Expenses are reported; Net Income = Total Revenues − Total Expenses.
Balance Sheet: Assets, Liabilities, and Stockholders’ Equity are presented after adjustments.
Statement of Retained Earnings: Beginning Retained Earnings + Net Income − Dividends = Ending Retained Earnings.
Example relationship:
- $\text{Net Income} = \text{Total Revenues} - \text{Total Expenses}$
- $\text{Retained Earnings}<em>{\text{end}} = \text{Retained Earnings}</em>{\text{beginning}} + \text{Net Income} - \text{Dividends}$

Temporary accounts (revenues, expenses, dividends) are closed to Retained Earnings to reset their balances for the new period.
Two closing entries are required:
1) Debit each Revenue account and credit each Expense account; transfer the net difference to Retained Earnings.
2) Credit Dividends and debit Retained Earnings. This zeroes income statement accounts and the Dividends account.
After closing, income statement accounts and Dividends have zero balances; only permanent accounts remain in the post-closing process.

Purpose: verify that permanent accounts balance after closing.
Contains only permanent (real) accounts: assets, liabilities, and equity accounts (including Retained Earnings).
Debits must equal credits.

Adjustments ensure revenues and expenses are recorded in the period in which they are earned or incurred.
Without adjustments, financial statements would be incomplete or misleading.
Example impact: adjustments affect net income and, subsequently, Retained Earnings.

Deferral adjustments: recognize expenses/revenues after initially deferring; typically involve assets or liabilities (e.g., Prepaid Rent, Supplies, Deferred Revenue).
Accrual adjustments: recognize revenues/expenses before cash changes hands; typically involve receivables/payables (e.g., Accounts Receivable, Salaries Payable, Interest Payable).
Adjustments never involve cash flows.
The accounting cycle (simplified): analyze → journalize → post to accounts → prepare unadjusted trial balance → adjust → adjust trial balance → financial statements → close → post-closing trial balance.

Accounting equation (at any time):
$\text{Assets} = \text{Liabilities} + \text{Stockholders' Equity}$
Net income: $\text{Net Income} = \text{Total Revenues} - \text{Total Expenses}$
Retained Earnings: $\text{RE}<em>{\text{end}} = \text{RE}</em>{\text{beginning}} + \text{Net Income} - \text{Dividends}$