chapter 3

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20 Apr 2012
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Chapter 3: Adjusting the Accounts
Chapter 3
1. Time Period Assumption
1.1 The time period assumption assumes that the economic life of a
business can be divided into artificial time periods.
1.2 Monthly and quarterly time periods - interim periods.
1.3 An accounting time period that is one year in length - fiscal year.
2. Recognizing Revenues and Expenses
2.1 The revenue recognition principle states that revenue must be
recognized in the accounting period in which it is earned.
2.2 The matching principle states that expenses are to be recognized in
the period when efforts are expended to generate revenues. Match
expenses with revenues.
3. Accrual vs. Cash Basis of Accounting
3.1 The accrual basis of accounting: revenues are recognized when
earned and expenses are recognized when incurred, regardless of
when the cash is received or paid.
3.2 The cash basis of accounting records revenue only when cash is
received and expenses are recorded only when cash is paid. The cash
basis violates both the revenue recognition and matching principles,
and is not in accordance with GAAP.
4. Basics of Adjusting Entries
4.1 Adjusting entries are required every time financial statements are
prepared.
4.2 Adjusting entries are recorded in the general journal and follow the last
transaction entry. They are posted to the ledger accounts at the end of
the accounting period.
4.3 Each adjusting entry affects one balance sheet account and one
income statement account.
5. Types of Adjusting Entries
5.1 Adjusting entries can be classified as prepayments, accruals, or
estimates.
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