Accounting Adjustments and Periods Quiz

Adjusting Journal Entries (AJE)

• Prepare and present fair financial statements
• Used to adjust account balances to correct them
• Determine the profit or loss for a business
• Used to record revenue and expenses for the correct accounting period
• Recognize revenue when it was earned and expenses when they were incurred
• Not dependent on receiving or paying cash

Accounting Period

• The subdivided economic lifetime of a business
• Allows for regular financial statement preparation
• Financial statements should be prepared at least annually
• Interim periods are less than a year, such as monthly, quarterly, or semi-annually
• Interim periods allow for financial statements to be prepared more regularly to aid planning and decision-making

Calendar and Fiscal Periods

• Calendar periods are 12 months and cover January 1st to December 31st
• Fiscal periods are also 12 months, beginning and ending at different times of the year
• Examples of fiscal periods include: February 1st to January 31st, March 1st to April 30th, and April 1st to May 31st

Cash Accounting

• Income is recorded when cash is received
• Expenses are recorded when cash is paid
• There is no "receivables or payables" account

Accrual Accounting

• Income is recorded when goods are delivered or services are rendered, regardless of cash payment
• Expenses are recorded when incurred, even if there has not been a cash payment
• Common adjustments:
  • Deferrals
  • Accruals

Deferrals

• An expense that has already been paid but not yet incurred
• Revenue that has already been collected but not yet earned

Common Deferral Accounts

• Prepaid Expenses: Record the expired amount of prepaid rent, prepaid insurance
• Depreciation Expenses: Record depreciation for assets like buildings, equipment, furniture, and machinery
• Precollected Income (Unearned Income): Record income earned from advance payments such as unearned rent income or unearned interest income
• Supplies Usage: Record expenses associated with the use of assets, such as supplies

Accruals

• Recording an expense that has been incurred but not yet paid
• Recording revenue that has been earned but not yet collected

Common Accrual Accounts

• Accrued Income: Record unrecorded income that results in receivables
• Accrued Expenses: Record unrecorded expenses that result in payables
• Doubtful Accounts (Bad Debts): Record bad debts (uncollectible accounts) associated with accounts receivables
• Ending Inventory: Set up the ending inventory account for merchandising businesses

Revenue Recognition Principle

• Revenue is recognized when:
  • It is probable that economic benefits will flow to the enterprise
  • The economic benefits can be reliably measured
  • Services are rendered or goods are delivered to the customer

Expense Recognition Principle

• Expenses are recognized when:
  • It is probable that a decrease in future economic benefits related to a decrease in an asset or an increase in liabilities has occurred
  • The decrease in economic benefits can be reliably measured
  • Expenses incurred during an accounting period should be matched to the revenues earned within the same period to determine profit or loss

Effects of Omitting Adjusting Journal Entries

• Account balances may not be adjusted or corrected
• Resulting financial statements may not fairly represent the financial position of the business
• Potential for misstatements in net income
• Could lead to inaccurate analysis and decision-making by stakeholders